US Weekly Economic Commentary: Likely to tip into recession

Worsening financial conditions imply that the US is increasingly likely to tip into recession.

In recent weeks, stock prices posted large declines, bond yields rose, risk spreads widened sharply, and the dollar appreciated on foreign exchange markets. Hawkish forecasts and communication from Federal Reserve policymakers buttressed expectations that the Fed will hike interest rates several more times in coming months, reinforcing the tightening of financial conditions that has occurred.

The global outlook has deteriorated due to fall-out from war in Ukraine, including steep increases in energy prices in Europe, and to reflect tightening of global financial conditions as other major central banks join the Fed in hiking interest rates. We expect outright declines in real GDP beginning as soon as the fourth quarter of this year and continuing into subsequent quarters sufficient to qualify as an outright recession.

We expect the recession to be mild in terms of the decline in GDP related to past recessions, with inventories not subject to excessive overhangs and household balance sheets in relatively healthy shape. Improvements in supply chains will also help to moderate the severity of the downturn. Nevertheless, we expect the unemployment rate to rise to approximately 6%.

We will issue our fully updated forecast on Oct. 10.

Tracking estimate revised

This week we revised up our tracking estimate of third-quarter GDP growth by 1.8 percentage points to 2.2%, an extraordinarily large revision. This was largely due to sharp upward revisions to net exports and inventory investment implied by advance economic data for August on international trade in goods and on inventories. The trade data suggest that real net exports rose nearly $180 billion in the third quarter and contributed approximately 3 percentage points to quarterly GDP growth.

Nominal goods exports declined in August, but not nearly as much as we had assumed. The August figure leaves our estimate of real goods exports in line with a broadly firming trend. A strong dollar and weakness abroad should soon undermine exports and soften this trend.

Nominal goods imports also declined in August; we had assumed little change. This would leave our estimate of real goods imports in line with what has been a declining trend in recent months. The large increase in inventories in August merely delays what we expect will be a declining profile in nonfarm inventory investment in coming quarters.

The Fed's next move

More broadly, the upward revision to our estimate of third-quarter GDP growth should not obscure the negative implications from tighter financial conditions and a deteriorating global backdrop that are likely to tip the US into recession.

Comments from policymakers on the Federal Open Market Committee (FOMC), including Vice Chair Brainard, confirm that Fed rate hikes will continue through this year and likely into the first part of next year. The size of rate hikes will eventually shrink if data show that inflation is easing on a sustained basis and inflation expectations are consistent with the Fed's longer-run 2% inflation target.

The outlook for the upcoming FOMC meeting on Nov. 2 is uncertain, with a rate hike of either 50 or 75 basis points possible. We expect that the upper end of the target range for the federal funds rate will rise to between 4½% and 5% by next spring, from its current setting at 3¼%.

This week's US economic releases:

• Construction spending: We estimate a 0.3% decline in August. This would continue a run of monthly declines reflecting contraction in the residential sector, as single-family sales, permits, and starts have been undermined by rising mortgage rates.
• Manufacturers' orders: Orders for durable goods were already reported to have declined 0.2% in August. Consensus estimates imply an increase in orders for nondurable goods in August.
• Light vehicle sales: We estimate 14.1 million units for September. This would be up somewhat from recent months.
• Nominal trade deficit: We estimate the deficit narrowed in August by $2.2 billion to $68.5 billion.
• Nonfarm payroll employment: Consensus estimates imply ongoing strength in labor markets through September. We expect labor markets to cool this fall and winter as the US economy tips into recession.

Posted 04 October 2022 by Akshat Goel, Senior Economist, US Macro and Consumer Economics, S&P Global Market Intelligence and

Ben Herzon, Executive Director, Research advisory specialty solutions, S&P Global Market Intelligence and

Ken Matheny, Executive Director, Research Advisory Specialty Solutions, S&P Global Market Intelligence

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.