- Dan Porto
US Economy May 2022 Will Fed strike the right balance ??
After two years of the pandemic, the U.S. economy now faces several challenges which keep central bankers awake at night. Supply chain interruptions caused by China's covid breakout, Ukraine crisis, labor shortages, and 40-year high inflation are affecting growth expectations and market morale in global markets. Having said that, Gross Domestic Product (GDP), which is the total value of goods and services provided by the economy, fell 1.4% on an annualized basis in the first three months of 2022, a considerable dip from the 6.9% increase recorded in the fourth quarter of 2021 amid the recovery of the pandemic. This is the first downturn since the spring of 2020 when a pandemic-related shutdown slowed economic development. The contraction stemmed from a widening trade deficit, a slower pace of inventory investment by businesses compared to the previous year, and the fading government stimulus associated with the pandemic. Moving forward, the unexpected downturn and increasing inflation pose a problem for U.S. President Joe Biden and Democrats as they prepare for the November midterm elections. Furthermore, the data adds to concerns that rising inflation and the potential of Federal Reserve rate hikes will trigger an economic deacceleration. Many economists believe that the dismal economic data for Q1 will unlikely alter Fed's plan and the economy can tolerate rising interest rates and return to modest growth in the second quarter and beyond, owing in part to strong consumer and corporate spending resiliency. The major question would be how the Fed can strike the correct balance between reducing price pressures and sustaining economic growth.
U.S - GDP QoQ
Consumer and business spending remains resilient while the trade deficit widens. Consumer expenditure, the primary driver of the U.S. economy, increased in the first three months of the year. Personal consumption expenditures climbed at a seasonally adjusted annual rate of 2.7% in the fourth quarter of last year, compared to 2.5% in the fourth quarter of the previous year. Companies are also investing in factories, equipment, and software, all of which will increase productivity in the medium and long term. Business investment increased at a 9.2% annual rate in the first quarter, up from 2.9% in the fourth quarter of 2021. However, Because of the shortage of workers market conditions shifted as employers cling to employees, business hiring ramped up, and wages improved, eventually leading to high consumer spending. Nevertheless, many of the positives were negated by one-off factors. Most notably, imports increased dramatically during the first quarter as U.S. supply failed to keep up with rising demand. Exports declined 5.9% while imports increased 17.7%, resulting in a 3.2% point negative on headline GDP from net exports. In addition, a 0.8% reduction (annually) in company inventories impacted the total output.
High inflation weighs on consumer spending power, while Fed is ready with a 50 bps hammer on the table. Despite the fact that average hourly earnings increased by 5.6% throughout the same time period. Inflationary pressures are eroding many workers' pay raises, and rising costs are posing problems for many firms. Having said that, the consumer price index increased 8.5% year on year in March, a four-decade high. Furthermore, the Fed's preferred price gauge, the Personal Consumption Expenditure Index, climbed to 7% in Q1 2022 from 6.4% in the previous quarter, indicating further price pressure. The covid in China and the war in Ukraine have added to the pricing pressure, making everything more expensive, from bread to cheese, oil, and commodities. Accelerating labor costs in the United States and a strong consumer is effectively giving the Federal Reserve the go-ahead to raise interest rates by a half-point next week to tamp down pricing pressures.
US Consumer Price Index %
Strong labor market conditions, resiliency in the service sector, but weak manufacturing growth. The job market in the United States remains tight, with the unemployment rate remaining at 3.6% in March, down from 3.8%in February. In addition, the labor force participation rate has increased to 62.4%, exceeding expectations of 62.2%. The only miss was in nonfarm payrolls, which were 431k instead of the projected 490K. Furthermore, the service sector remains resilient, with the ISM service PMI reading 58.3 vs 56.5 previously. The manufacturing sector remains slow, with an ISM manufacturing PMI of 57.1 below expectations of 59.
Unemployment Rate - U.S.
While the U.S. and its allies push sanctions on Russia, geopolitical tensions remain on the desk. According to the most recent geopolitical news, Germany is facing gas supply problems. EU leaders are deliberating on measures that will allow them to pay Russia in a sanctioned compliant manner. A sudden ban on Russian crude, on the other hand, would produce a recession, given the EU member states' heavy reliance on Russian energy products. However, Germany has stepped up its role in the geopolitical conflict committing to cut off its dependancy on Russian oil in the coming months. Furthermore, China is in trouble, and when China is in crisis, so is global growth. Fresh Covid outbreaks, as well as the government's tough policies to contain them, are frightening global investors, who are concerned that Chinese shutdowns could ripple around the world, decreasing demand and disrupting supply chains. In the Ukraine-Russia conflict, President Biden requested that Congress provide $33 billion in aid to Ukraine in order to strengthen military support for the country. Finally, oil rose for the fifth month in a row in April, the longest winning streak since January 2018. Russia's invasion of Ukraine has fueled inflation, prompting the United States and its allies to agree last month on a coordinated release of strategic crude reserves to cool rising energy costs. The rise in oil prices causing pain at the pump for consumers in the United States and internationally.
The following sections will show how the economic situations and geopolitical tension have shaped currency and capital markets in the U.S.
US Dollar
The U.S. dollar reached a 20-year high in April, its strongest month in seven years, as global economic concerns and a hawkish Federal Reserve boosted demand for the greenback. Furthermore, fears of an economic downturn in Europe and China as a result of the Ukraine crisis and Covid lockdowns, respectively, fueled safe-haven flows into the dollar. Having said that, the dollar rose to a 20-year high against the Yen in the last week of April, as dovish Bank of Japan policies weighed on the Japanese currency. It also touched a five-year high against the Euro, which has fallen dramatically since Russia's invasion of Ukraine, as investors have been concerned about Europe's energy security, inflation, and GDP. On the data front, the greenback was supported by solid consumer spending, a tight labor market, and robust inflation data, which continue to support the Federal Reserve's 50 basis point rate rise expectations. On the other side, the index has been pulled down by dismal GDP figures and positive corporate earnings reports. Nonetheless, the U.S. dollar index finished the month near a 19-year high. Moving forward, investors are anticipating a critical Federal Reserve meeting in the first week of May, when interest rates are largely projected to be raised by a whopping 50 basis points. The Fed's wild card will define the dollar's course for some time.
DXY Index - 20 year high
Markets - Stocks and Bonds
Volatility has been a recurring trend in markets this year, with investors concerned about China's fight to curb Covid, Russia's war in Ukraine, and fears that central-bank tightening will tip the U.S. economy into recession. The Nasdaq plummeted 13.3% in April, its worst monthly performance since October 2008, when the market was in the grip of the financial crisis. The S&P 500 fell 8.8% in March, its worst month since March 2020, when the Covid epidemic began. The Dow Jones Industrial Average was down 4.9% for the month. Technology companies have been at the crux of the April sell-off, as high-interest rates erode valuations and supply chain concerns caused by Covid and the Ukraine war disrupt operations. Also, bond yields have risen this year as investors braced for tighter monetary policy, with the 10-year Treasury note yielding around 2.9%, up from 1.5% at the end of 2021. Despite what we consider to be a healthy overall earnings period thus far, the positive results appear to be overshadowed by some of the larger concerns about inflation and the Fed. Moving forward, investors are anticipating the Fed's rate rise decision, which will strive to reduce record-high inflation and achieve a balance of economic growth.
Stock Market - Nasdaq vs Dow Jones vs S&P 500
In a nutshell, despite the fact that the U.S. economy reported terrible GDP data, it is not a harbinger of recession because U.S. consumer and corporate spending remains resilient for the time being, and many economists feel that the U.S. economy is ready for a 50 basis point rate hike. The most serious issue is that inflation is quite high, presenting the prospect of a boom-to-bust situation. Furthermore, it is unclear how far consumer pockets will be spared as a result of this rapid inflation. Also, the forecast for price declines is complicated by the Covid lockdowns in China and the crisis in Ukraine. Coming up, the Fed faces a major test as it considers a half-point rate hike, the largest since 2000, and a succession of raises such that interest rates reach 2.8% by mid-2023. A high fund rate means that the cost of loans, credit cards, and mortgages will rise. The fascinating element will be striking a balance between quenching price pressures and pressing the economic brakes too hard.
April's Economic Calendar
Monday 05/02/2022 – ISM Manufacturing PMI(Apr) ¦ S&P Global Manufacturing PMI(Apr)
Tuesday 05/03/2022 – Factory Orders (Mar)
Wednesday 05/04/2022 – ADP Employment change (Apr) ¦ ISM Services PMI(Apr) ¦ Fed Interest rate decision
Thursday 05/05/2022 – OPEC Meeting ¦ Non-farm Productivity Q1
Friday 05/06/2022 – Nonfarm Payrolls(Apr) ¦ Labor Force Participation Rate(Apr) ¦ Unemployment Rate(Apr)
Wednesday 05/11/2022 – CPI (Apr)
Thursday 05/12/2022 – PPI Index ex-food and energy (Apr)
Friday 05/13/2022 – Michigan Consumer Sentiment Index(May) PREL
Tuesday 05/17/2022 – Retail Sales (Apr)
Wednesday 05/18/2022 – Building Permits (Apr) ¦ Housing Starts (Apr)
Thursday 05/19/2022 – Philadelphia Fed Manufacturing Survey (May)
Monday 05/23/2022 – Chicago Fed National Activity Index (Apr)
Tuesday 05/24/2022 – S&P Global Composite PMI (May) ¦ S&P Global Manufacturing PMI (May) ¦ S&P Global Service PMI (May) ¦ New Home Sales (Apr)
Wednesday 05/25/2022 – Durable Goods Orders (Apr) ¦ FOMC minutes
Thursday 05/26/2022 – Core PCE Q1 ¦ GDP Q1 ¦ PCE Q1 ¦ Pending Home Sales (Apr)
Friday – 05/27/2022 – Core PCE Price Index (Apr) ¦ Personal Income (Apr) ¦ Personal Spending (Apr) ¦ Michigan Consumer Sentiment Index (May)
Monday – 05/31/2022 – Housing Price Index (Mar) ¦ Chicago PMI (May) ¦ Consumer Confidence (May) ¦ S&P/Case Shiller Home Price Index (Mar)
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