A World At Work

An Inflationary Recession May Be Closer Than Expected

While we approach peak inflation, consumer confidence and manufacturing indicators are tumbling

New research from SwissRe, in its World insurance Sigma Report, takes a sobering measurement of global economic conditions. Excerpts are provided below. Access the full report here.

Annual inflation for June (9.1%) beat last month’s 40-year high, while rate-sensitive personal consumption began to drag on the economy. Stickier subcomponents of CPI such as shelter and services are showing persistence and energy prices have regained steam. We raise our CPI inflation forecast for full year 2022 to 7.8% from 7.4%. While we approach peak inflation, consumer confidence and manufacturing indicators are tumbling and we cut our real GDP growth forecast to 2.0% for 2022 and 1.1% for 2023. As the Fed prioritizes the taming of inflation, we now predict a higher year-end Fed Funds Rate with a midpoint of 3.625%, and a higher 10y Treasury yield of 3.2% at end-2022.

Key takeaways:
• Annual inflation accelerates to a new peak of 9.1% in June. Stickier subcomponents such as shelter and
services show persistence and energy prices regained steam.
• A contraction in rate-sensitive consumption in the month of May suggests an inflationary recession
may occur sooner than previously anticipated.
• We now expect a steeper Fed Funds Rate trajectory, reaching 3.50-3.75% by year-end, as the Fed prioritizes
fighting inflation, which we now see higher at 7.8% for 2022.
• In light of tighter financial conditions and softer consumption activity, we cut our real GDP growth forecasts to
2.0% for 2022 and to 1.1% for 2023 – the latter well below consensus.

Annual headline inflation climbed again in June, surpassing last month’s high. The year-on-year (yoy) reading of 9.1% is up from the 8.6% rise in May, which was a 40-year high at the time. Energy prices regained steam and rose 7.6% month-over month (mom), equating to a 41.6% yoy clip. Services prices continued a steady climb since January 2021, while the price of shelter – which carries the most weight in the broader index – contributed the most to inflation and currently runs at an annual pace of 5.6% not seen since February 1991. With these higher readings, we raise our inflation forecast for 2022 to 7.8% from 7.4%, while keeping the 2023 forecast unchanged at 3.3%. A New York Fed survey released earlier this week showed that consumers see inflation rising further over a one year-ahead horizon, but expressed a decline of inflation over the medium and long term – suggesting effectiveness in the anchoring of inflation expectations by policymakers.

Contraction In Consumption

A contraction in rate-sensitive personal consumption in May suggests an inflationary recession may occur sooner than anticipated...

A contraction in rate-sensitive personal consumption in May suggests an inflationary recession may occur sooner than anticipated. Personal consumption in May contracted 0.4% compared to April. Consumption of services expanded, but that of durable goods fell sharply (-3.5%), indicating that the Fed’s hawkish interest rate decisions may already be biting the economy. Consumer confidence and manufacturing indicators continue to weaken, confirming the picture of economic slowdown or perhaps a technical recession starting in Q2 – as suggested by the Atlanta Fed’s GDP now estimates. With the even tighter-than-anticipated financial conditions for this year, we cut our growth forecasts to 2.0% and 1.1% from 2.8% and 1.2% in 2022 and 2023 respectively. For next year, we are considerably more pessimistic than consensus (now at 1.7%). We also revise our 10y govt bond yield forecasts for this year and next to 3.2%

Indicators suggest a housing market inflection point is approaching. The S&P Case-Shiller home price index continued to rise at a blistering pace in April, up 1.5% from the prior month and up 20.4% from a year earlier. The average growth rate of the preceding twelve months (1.6%) quadrupled its historical average. However, cooling may be just around the corner as inventory begins to increase in tandem with decreasing affordability. The amount of new privately-owned housing units under construction is at its highest level since 1973, while the volume of mortgage applications continues to contract on a year-to-date basis. Homebuilders sentiment, a leading indicator for the housing market, declined for a sixth consecutive month in June, although the reading (67) remained well above the 50 mark denoting expansion.

Broader Signs Of Softening

Labor market shows strength, but broader signs of softening in the economy. The US economy added 372 000 jobs in June, an unexpectedly strong gain though slightly lower than previous months. The unemployment rate remains at 3.6%. Most job gains occurred in professional and business services, leisure and hospitality, and in health care. Employment in retail trade increased slightly after declining in May.

Nonfarm employment is nearing its pre-pandemic level and is currently 0.3% below. New claims for unemployment benefits reached a four-week moving average of 232 500 in the week ended 2 July, roughly in line with pre-pandemic levels. Job openings declined 4% in May. In June, rising interest rates and high prices pushed new-vehicle affordability lower, bringing the annualized number of new vehicle sales through 1H22 more than 1 million below the 2021 figure. Consumer sentiment hit a 16-month low according to the Conference Board, with the negative outlook driven
by rising gas and food prices. In manufacturing, the June ISM index dropped to 53.0 from 56.1, the lowest reading since June 2020. These last two are well in line with expectations of an economic slowdown in the second half of the year.

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