Growth
Following two consecutive quarters of negative GDP growth, 3Q22 real GDP showed the economy grew by a 2.6% annualized rate, slightly stronger than the 2.4% consensus expectation. Much of the gain came from a large upswing in trade, while beneath the surface the economy is still losing momentum in both growth and inflation. Real consumer spending continued to soften and construction spending was very weak with the climb in interest rates. However, investment spending is still holding up and the GDP price deflator declined markedly to 4.1% from 9% last quarter. Moreover, with pent-up demand for autos and a still very tight labor market, it’s clear the economy is not yet in recession.
Jobs
The September Jobs report showed the economy continues to make progress in easing labor market tightness. The recent pace of job growth remains solid at 263K but has moderated, and wage growth continues to run at a more modest pace of 0.3% m/m. Private sector job gains were broad-based with the greatest strength in leisure and hospitality and health care. The unemployment rate fell back down to 3.5%. In combination with job openings falling, continued progress on job gains, particularly in the sectors with the greatest demand, is a welcome signal for investors that a more balanced labor market could put a lid on inflationary pressures and the Fed’s hawkish trajectory.
Profits
The 3Q22 earnings season is underway with 64.4% of market cap having reported. Our current estimate for 3Q22 S&P 500 operating earnings per share (EPS) is $52.42 ($44.73 ex-financials), representing year-over-year (y/y) growth of 0.8%. So far, 58% of companies have beat earnings expectations and 51% have beat revenue expectations. Companies are facing significant headwinds with a slowdown in demand and a surge in the dollar. However, higher energy prices, a resumption of travel and better-than-expected consumer spending and industrial production data have supported earnings.
Inflation
Hot inflation is beginning to cool down but continues to surprise expectations to the upside. The headline PCE price index rose 0.3% m/m and +6.3% y/y in September. The core PCE deflator also rose +0.5% m/m and +5.1% y/y. After a string of upside surprises, the September CPI report came in hotter than expected. Headline CPI rose 0.4% m/m while core CPI jumped 0.6% m/m. With this report, headline CPI inflation eased slightly to 8.2% y/y in September from 8.3% y/y in August. While energy prices continued to decline, other areas of inflation, such as food prices, services inflation and owners’ equivalent rent, still remain hot.
Rates
Persistent inflationary pressures have pushed the Fed to accelerate its rate hiking trajectory. At its September meeting, the FOMC announced another 0.75% increase in the federal funds rate to a range of 3.00%-3.25%. In its updated dot plot, the committee expects to lift rates to 4-5% next year and doesn’t expect to begin lowering rates until 2025. The tone of the committee remains hawkish with a focus on taming inflation that runs well above its 2% target. Strong job growth and persistent excess demand for labor suggest a soft landing is still possible. However, aggressive Fed tightening keeps the probability of recession sometime next year elevated.
Risks
- The Fed could push the economy into recession if it overtightens policy in response to supply-driven inflation.
- Heightened geopolitical tensions with Russia could result in continued energy shortages, low consumer confidence and dampened growth.
- Markets may remain depressed and volatile until investors receive clarity on inflation and the Fed.
Investment Themes
- After this year’s sell-off, fixed income now offers more protection against a market correction or economic downturn.
- U.S. equity investors may use profits as a guide in a rising rate environment.
- Long-term growth prospects, a falling dollar and wide valuation discounts support international equities.
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Originally Posted October 31, 2022 – Economic Update
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