At the peak of the railroad boom of the late 19th century, the Framingham and Lowell line was incorporated to transport goods and passengers up and down the western outskirts of Boston. Over the years, the traffic dwindled, the line was sold and resold and eventually abandoned. However, for more than three decades now, some enterprising local citizens have pursued the construction of a bike trail along the old abandoned line, which is now, finally, mostly complete.
I am the beneficiary of their perseverance, as the trail passes only a few hundred yards from our house and early in the morning you can find me jogging out onto the path. It is a peaceful place at all times of the year, but particularly now, when the fog hangs heavy over the ponds and the only sound is the padding of my own feet through the fallen leaves. It is, I suppose a little spooky, before the fog lifts. But by the time I’m running homeward, the sun has melted the fog and shines on the multi-colored trees, double-exposed over still waters. There is a clarity and comfort in the scene even though we all know what comes next in the seasons of New England.
Markets hate uncertainty and, in the last week of October, a thick fog of uncertainty hangs heavy over the economic, political and central bank landscape. Data releases and events over the next three action-packed weeks should lift some this fog and provide a clearer picture of the outlook. Of course, how these uncertainties are resolved is important. However, in a world where the biggest fears haunting investors are the largely opposite threats of inflation and recession, the clearer picture of the investment environment that should emerge over the next few weeks could in itself be positive for the risk assets that have been so pummeled thus far in 2022.
U.S. Economy: The Bump Before The Slump
On the U.S. economy, this week’s GDP report could show surprising strength, especially following two negative quarters and numerous predictions of imminent recession.
Our models suggest a real GDP gain of 3.3% at a seasonally adjusted annual rate. Consumer spending likely grew by less than 1% annualized and home-building may have plunged by as much as 20% annualized. However, inventory rebuilding appears to have been strong, particularly when adjusted for somewhat lower inflation during the quarter, and trade numbers showed significant improvement.
It should be stressed, however, that this looks like a bit of a one-hit-wonder and growth could easily turn negative in both the fourth and first quarters, as volatile trade and inventory data turn more negative. The reality is that, with mortgage rates more than doubling since the start of the year, the U.S. dollar now up almost 20% year-over-year and the federal budget deficit falling quickly, there is more braking power being inflicted on the U.S. economy than will be at all apparent in the third-quarter GDP report.
Going forward, growth could well turn negative in the fourth quarter and will likely be very weak over the next year until housing starts bottom and the trade and budget deficits hit a trough as a share of GDP, likely sometime in the middle of 2023. Thereafter, slightly stronger economic growth could emerge. However, there is little reason to expect booming growth at any time over the next few years without the v-shaped forces of a recovery from a deep recession or the adoption of far more enlightened policies to trigger stronger labor force and productivity growth.
Inflation numbers may also continue to look strong in the short run. We expect the September headline personal consumption deflator, due out on Friday, to show a monthly gain of 0.3% or 6.3% year-over-year. While this would be below its June peak of 7.0% year-over-year, it would be far above the Fed’s 2% year-over-year target. Moreover, early indications suggest that the October consumption deflator gain could tick up to 0.4%.
However, this is also likely a prelude to much softer numbers. Data show a clear easing of supply-chain problems and a general softening in commodity prices. If this continues, we expect that year-over-year headline consumption deflator inflation could fall to 5.8% in the fourth quarter, 4.7% by the first quarter of 2023 and 2.9% by the fourth quarter of 2023.
Next week’s releases on job openings and employment should provide further clarity on both growth and inflation. Even with a continued decline from its springtime peak, the number of job openings likely exceeded 9 million at the end of September and this suggests a further solid job gain and a stable unemployment rate in October. While this continues to protect the economy from the threat of immediate recession, investors will be watching wage gains closely. Despite very significant increases in the cost of living and a very tight labor market, average hourly earnings appear to be growing at a significantly slower pace than consumer prices, a trend that could help alleviate inflation pressures in the months ahead.
Investors will also be looking carefully at earnings. The earnings season so far has gone better than expected with the majority of companies surprising to the upside on both earnings and revenue. However, only 96 of the S&P500 companies had reported third quarter earnings as of last Thursday while 165 are expected to report this week alone, giving us a clearer picture of the ability of corporate America to defend margins in the face of slowing revenue growth and continued cost pressures.