ECONOMY SLOWING, NOT SHRINKING
According to our friends with LPL Research, many pundits are issuing recession warnings and saying the economy is heading for a hard landing. Amid the cacophony of voices, we think the economy is slowing just like central bankers want but not shrinking. Further, we argue that a slowing economy is very different than a shrinking one.
We believe the domestic economy will continue to grow this year. Other than the anomaly in Q1 GDP (gross domestic product), we think the economy has sufficient momentum to offset the inflationary pressures. “Our base case forecast includes an inflation rate that moderates as supply bottlenecks improve and we get some closure to the Russian war with Ukraine,” explained LPL Financial Chief Economist Jeffrey Roach.
The U.S. economy grew 5.7% in 2021 after contracting by 3.4% the previous year. Last year consumer spending was extremely robust, particularly on consumer goods as consumers were still less inclined to spend on services. Goods spending contributed roughly 2.7 percentage points to the headline growth rate, the highest since 1955. While we do not think consumer spending will continue at this clip in 2022, the consumer will likely weather the headwinds of high prices and geopolitical uncertainty and support the overall economy throughout 2022.
Consumer spending will likely slow the latter half of this year as inflation pressures weigh on consumers and wage growth likely lags inflation. These factors in tandem will erode consumers’ real purchasing power. However, recent spending activity shows a fairly stable consumer. Real consumer spending rose 0.7% in April, the fourth consecutive monthly increase in real spending. The job market is tight, supporting consumer spending from gains in personal income, but the real cushion for consumers comes from roughly $3 trillion in excess savings accumulated during the pandemic.
INVENTORY REBUILDING COULD ADD TO GROWTH If supply bottlenecks improve, we expect to see firms restocking inventories, supporting underlying economic growth. As firms have improved access to required inputs and as the transportation sector recalibrates to the current environment, the economy could likely see growth in the latter half of this year and avert recession.
RISKS TO THE OUTLOOK A still unknown variable to our forecasts is the Federal Reserve’s shrinkage of its balance sheet, known as quantitative tightening (QT). The Fed will only allow its balance sheet to shrink incrementally over time while also paying attention to the impact QT is having on the markets. The Fed has stated that QT could “replace” several rate hikes as a way to tighten financial conditions; therefore, we could conceivably see a lower fed funds terminal rate than what is already priced in the markets, which should help the Fed navigate a “softish” landing of the economy slowing but not shrinking.
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