This article was originally published on invesco.com by Kristina Hooper.
- The US economy. It might not feel like a recession, but it feels like a slowdown. There is definitely real consumer pain.
- UK inflation. The Bank of England is in a delicate balancing act, trying to tame inflation without snuffing out its economy.
- China’s housing market. China’s economy is still recovering from COVID lockdowns but is now facing headwinds from the property sector.
My 16-year-old daughter plays club basketball and so, as we have done for the last several years, we spent time in July traveling to different tournaments in multiple states (with a stop at the beach along the way). From Louisville, Kentucky, to Michigan City, Indiana, to Chicago, Illinois, to Uncasville, Connecticut (and a few other stops on the road in between), we saw a US economy that was quite strong. There were many consumers out dining and shopping and a number of “help wanted” signs were out — despite high gas prices, increased costs for food, and reports of very negative consumer sentiment.
We saw this economic strength on full display with July’s US jobs report. Far more non-farm payrolls were created than expected. Wages rose an unexpectedly high 0.5% for the month and are up 5.2% for the year — after appearing to be cooling last month.1 The Twitterverse lit up after the jobs report was released, with many economists, strategists and plain old pundits heralding what they viewed as an economy on fire that refused to be hindered by the Federal Reserve’s aggressive tightening. I felt like I was living in a Queen mini rock opera, with the lyrics from “Don’t Stop Me Now” swirling in my head.
Maybe not a US recession, but a slowdown
But the reality is far more nuanced. A deeper dive into the US employment situation report shows that the number of part-time jobs held by people who wanted full-time employment increased by 303,000.1 Not an ideal jobs picture — but not terrible either. After all, the Institute for Supply Management’s Purchasing Managers’ Index (PMI) survey figures for July showed an economy that is still in expansion — July manufacturing PMI was 52.8 while non-manufacturing PMI was 56.7.2 However, the US economy is most definitely not on fire.
And that’s the key takeaway. It might not feel like a recession, but it feels like a slowdown. There is definitely real consumer pain; it has been reported that more Americans are skipping meals because of higher food prices. And households are racking up credit card debt, likely because they can’t afford living expenses. All that shouldn’t be a surprise given that real incomes have fallen significantly this year. This situation — a US economy that has both significant strengths and weaknesses — was one of the disconnects I wrote about in a recent blog.
And so yes, despite the Fed’s very rapid and substantial tightening, the US economy seems to be rather resilient and certainly doesn’t feel like it’s in recession — at least not yet. The reality is, as Fed Chair Jay Powell recently acknowledged, that much of the Fed’s tightening has yet to turn up in economic data — there is a lag, of course. So it’s only a matter of time before we see more signs of a slowdown in the jobs reports and elsewhere. At the risk of sounding like a broken record, the Fed’s actions will largely dictate just how significant the slowdown is.
Despite those areas of weakness — and the two consecutive quarters of contraction for US gross domestic product — I think it’s likely that the Fed will raise rates by 75 basis points in September given the robust jobs report. However, more data will be coming in before that decision has to be made — namely the Consumer Price Index (CPI), which comes out on Wednesday, Aug. 10. I’ll be giving my takeaways on that CPI report and answering live questions in a LinkedIn Live event Wednesday morning — you can register for that event here.
For Bank of Canada, rates hikes may continue
Canada’s central bank seems to be a bit better at slowing its economy. Job losses in July’s jobs report were more than expected, albeit still modest. And average hourly wages, while still high, rose less in July than in June. But I suspect it will still be too high for the Bank of Canada, which is likely to continue raising rates despite its mega rate hike of 100 basis points just a few weeks ago. The Bank of Canada doesn’t appear poised to stop.
The Bank of England forecasts red-hot inflation
The chorus is singing “Don’t Stop Me Now” in the UK, but there, the song is about inflation. The Bank of England (BoE) surprised and dismayed some with its latest inflation forecasts. The BoE is now anticipating that inflation will peak at 13.3% in October — and that it will remain in double-digits into the second half of 2023.3 Yes, the BoE expects inflation to remain red-hot even as the UK economy is in recession.
That’s why the BoE had to bring out its jumbo-sized sledgehammer — hiking rates 50 basis points last week — which it hasn’t used in more than a quarter of a century. It seems reasonable to expect the Bank of England to hike another 50 basis points in September, although the demand outlook may restrict further hikes to 25 basis points.
As with other central banks such as the Fed and the European Central Bank, the BoE is in a delicate balancing act, trying to tame inflation without snuffing out its economy. And it could be attempting to perform this balancing act under great scrutiny if UK Foreign Minister Liz Truss, who is in the running, becomes the next Prime Minister, given her recent criticisms of the central bank.
The eurozone economy is under pressure
Inflation is also hot and doesn’t want to be stopped in the eurozone, although the eurozone economy is coming under very substantial pressure. It is going to be harder to stop eurozone inflation because most of it is not demand-driven, and so the ECB might “stop” the economy before it “stops” inflation.
The most recent manufacturing PMI was slightly in contraction territory, although the service sector PMI remains in expansion territory. However, Chris Williamson of S&P Global explained, “The eurozone economic outlook has darkened at the start of the third quarter with the latest survey data signaling a contraction of GDP in July. Soaring inflation, rising interest rates and supply worries — notably for energy — have led to the biggest drops in output and demand seen for almost a decade, barring pandemic lockdown months.”4
China seeks to calm its housing market
The lyrics of Queen’s mini rock opera would need to be edited for the property situation in China. The chorus could be: “Don’t stop paying your mortgage,” with the response being: “Then don’t stop construction.”
Some Chinese households have stopped paying the mortgage on their properties under construction because developers have stopped building the projects. China’s economy is still recovering from COVID lockdowns but is now facing headwinds from the property sector, so this will hopefully be resolved quickly. Policymakers are likely to strongly encourage consumers to pay their mortgages on time, lest they risk legal action from the banks, while also providing more liquidity to developers to restart dormant projects. We believe the government has the tools to ensure these risks don’t spread to the financial system.
Conclusion: Maintaining a long-term perspective
In conclusion, many central banks are on the move, and economic data can be quite concerning depending on the country. There will likely be more market volatility, especially given heightened geopolitical tensions and the potential for downward earnings revisions. I believe the best we can do as investors is maintain a long-term perspective. That means being well diversified across equities, fixed income and alternatives — and being tactically opportunistic if comfortable.
With contributions from Emma McHugh and David Chao.
1 ) Source: US Bureau of Labor Statistics, Aug. 5, 2022
2 ) Source: Institute for Supply Management, July 2022
3 ) Source: Bank of England, August 2022
4 ) Source: S&P Global, Aug. 3, 2022