Markets Weekly podcast – 20 June 2022

Henk Potts (HP): Hello. It’s Monday, 20^th June and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets.

My name is Henk Potts, Market Strategist with Barclays Private Bank, and after a dramatic week for investors, dominated by the biggest interest rate rise in nearly three decades from the Federal Reserve, I will step back from the mêlées of the markets to reflect upon the recent performance of the US economy, discuss its outlook and, of course, consider the future path of policy.

Despite being buffeted by soaring prices, the economic effects of the war in Ukraine, and persisting supply chain troubles, America’s economy seems to be weathering these pressures on growth better than many other developed countries. The US economy continues to be resilient in the face of weakening external demand, multi-decade high inflation, and tightening financial conditions.

While growth unexpectedly contracted in the first few months of the year, the underlying picture of the world’s largest economy still looks assured, as household consumption remains robust and labour markets continue to improve.

First glance, the first quarter growth came in much weaker than expected. In fact, activity declined by 1.4% on an annualised rate. This was significantly lower than the 6.9% growth recorded in the fourth quarter of 2021. It was the first drop in output seen since mid-2020 when COVID-19 restrictions decimated activity. Nevertheless, many economists dismissed the report as an indicator of an imminent recession given the contraction was primarily driven by weaker trade and slower inventory build.

Reduced external demand due to moderating growth elsewhere led to a 5.9% decline in exports from the United States during the course of the first quarter. Concerns over supply shortage due to disruption in China and the war in Ukraine encouraged, of course, companies to frontload imports, resulting in a widening of the trade deficit.

Inventory data, we should remember, does tend to be volatile. After a strong build in the fourth quarter, companies appeared cautious to increase their stock further over the course of the past two months. Nevertheless, domestic activity has been positive during the course of this year, driven by robust personal consumption and encouraging growth in terms of business investment.

If you look at personal consumption expenditures, which we should remember accounts for more than two-thirds of economic activity, have been very positive even after adjusting for inflation. The acceleration in spending has been driven by higher demand for goods and services. In services, spending momentum has picked up as US COVID-19 caseloads have declined, encouraging people to travel, to dine out, and to stay in hotels.

More spending was also seen in the likes of healthcare, recreation and transportation services. The outlook for the consumer, we think, remains underpinned by healthy labour markets, excess savings and a decrease in the savings rate.

A key component of that, of course, is the labour market. So, if you look at US unemployment, it’s fallen to 3.6%, a rate we last saw in February 2020, just before the pandemic really took hold, and represents a remarkable improvement on that 14.7% peak that was registered in April 2020 in the early days of the pandemic.

Nonfarm payroll data shows America’s economy has created more than 390,000 jobs per month over the course of the past year. Average hourly earnings rose 5.2% year on year in May, helping to offset the attrition in household purchasing power that’s been taking place.

If you are looking for a disappointment, perhaps it does come in the form, when it comes to labour reports, of the slow recovery that we’ve seen in terms of the supply of labour. The participation rate did improve in May up to 62.3%, but that’s still below those pre-pandemic levels.

With spending outpacing income gains, it is clear that consumers feel confident enough to dip into extra funds built up during the course of the pandemic. In April the savings rate dropped to 4.4%, comfortably below those pre pandemic levels. And, of course, with excess savings still of around $2.5 trillion and only a moderate pace of erosion, we expect private consumption to grow at 3% this year and so be supportive of growth.

Business investment is also an important contributor to growth. New orders for capital goods rose by a larger than expected amount over the course of the past few months after declines at the start of the year. In an effort to boost productivity and offset labour shortages, higher energy costs, and supply chain disruption, companies are increasing their investment in machinery.

Strong demand for communications and electrical equipment was confirmed by the robust increases that we have been seeing in terms of durable goods orders, so we expect growth private investment, which is a measure of the amount a company will invest domestically, to accelerate in the second half of this year and average 9% in 2022.

Of course, inflation does continue to be a problem. Hopes that US inflation had peaked in March were shattered after the Consumer Price Index surged to 8.6% year on year in April. Remember, that’s the fastest pace that we’ve seen since 1981. The increase was driven by rising costs of fuel, food and shelter as a result of the war in Ukraine and the reopening of the economy.

Energy prices jumped 34.6% from a year earlier, which was the most since 2005, while grocery prices rose 11.9% annually. That’s the fastest rate of increase since 1979. The only respite, I suppose, for policymakers in the recent inflation report was the moderation that we saw in terms of the core reading.

In terms of our inflation forecast, well, we have raised our US annual inflation projection for this year to 7.7%. We do anticipate that price pressures will begin to ease down into year-end driven by base effects, a gradual reopening in China and the unwinding of core goods inflation. So we forecast that CPI will print in December at around 6% and will trend lower during the course of next year to average something closer to 2.2%.

But, with unemployment heading back towards pre-pandemic levels and sky-high inflation, it’s no surprise that the Federal Reserve have increased the intensity of the policy normalisation timetable after ramping up the rate hiking cadence to 75 basis points in June, the biggest increase since 1994. We forecast further 50 basis point increases at both the July and September meetings.

We think the Federal Reserve will then dial down that intensity to 25 basis point increments in future meetings. We now think the terminal rate for Fed funds will be around about 3.5% in early 2023.

So, in terms of the economic outlook, the growth profile we think for the US economy remains intact, despite the broad range of global economic pressures and the impact of higher interest rates. Given the improving outlook in respect to COVID-19, the strength that we’ve been talking about in terms of the labour market, positive consumer spending, that pick-up in terms of capital expenditure from businesses, we anticipate the economy will grow somewhere around about 3% during the course of this year. Then, you start to see some of those pressures building once again, with growth easing maybe to around 1.7% as we look through the course of 2023.

And with that, I’d like to thank you once again for joining us. I hope that you found this US special edition interesting. We will, of course, be back next week with our latest instalment, but for now may I wish you every success in the trading week ahead.