Eye on the Economy Has Inflation Peaked?

HAS INFLATION

Peaked?

Markets received good news — or at least better than-expected news — with Wednesday’s consumer inflation report: The Consumer Price Index was up “only” 8.5% in July compared to a year ago. Nonetheless, this was lower than the 9% gain estimated in June and less than consensus forecast expectations. Combined with clear evidence of a February peak for the core Personal Consumption Expenditures measure of inflation (the Federal Reserve's preferred inflation gauge), the data appear to show that slowing economic conditions produced by tighter monetary policy from the Fed is lowering the rate of inflation growth.

The July inflation data does not mean prices are falling or will even stop increasing. But the rate of increase is slowing, and this trend is what the Fed wants to see. Consequently, the Fed is likely to increase the federal funds rate by less than 75 basis points at its September meeting. Bond markets liked the July inflation report as well, with the 10-year Treasury rate now at 2.8%, below the nearly 3.5% peak in mid-June.

This leaves open the question of whether a recession is underway in the United States. GDP data indicate the answer is yes. After posting a -1.6% growth rate in a disappointing first quarter of 2022, GDP registered another quarterly decline (-0.9%) during the spring, triggering the rule-of-thumb definition of a recession of two consecutive quarters of decline. However, the biggest missing ingredient, according to how recessions are officially defined by the National Bureau of Economic Research, is a weak labor market. In fact, for July, employment expanded by 528,000 jobs and the unemployment rate was a very low 3.5%.

However, these positive data are the result of a separate, ongoing, post-pandemic recovery in the service sector that is masking job losses due to GDP declines for the first half of 2020. Thus, the traditional readings of the labor market may create a disconnect between what appeared to be a recession for the first half of this year, and ultimately weakness in the job market that will materialize in late 2022 and early 2023.

BY: ROBERT DIETZ

Indeed, the Job Openings and Labor Turnover Survey data of open, unfilled jobs show a net slowdown in hiring intentions by employers as the number of open jobs has declined for three straight months, falling to 10.7 million open jobs in June. This is still a greatly elevated reading due to the ongoing labor shortage, but the recent trends show a pivot for the labor market that will be reflected in the monthly jobs reports later this year.

Overall, combining the two quarters of GDP declines with the ongoing housing downturn for sales, permits, starts and home builder sentiment, the evidence now exists that the economy experienced at the very least a downturn during the first half of the year, with a reasonable basis to call it a recession. Weak housing and economic data will continue in the coming months given tightening of financial conditions; however, some stabilization lies ahead as inflation appears to be at an inflection point and bond markets are signaling a deceleration of interest rate increases for long-term instruments like mortgages. As a result, the probability of a hard landing for the economy has slightly declined in recent weeks.