Financial update from Brewin Dolphin - 1 July 2022

July 2022

The Weekly Round-up

Friday 1 July 2022

In his latest weekly round-up, Guy Foster, our Chief Strategist, analyses data that suggests the US may already be in a recession.

The first half of 2022 finished with a further sharp fall in the equity market. In the end, markets received little support from pension funds rebalancing their portfolios, which will be underweight equities due to the sharp drawdowns experienced during the first half.

The source of angst for investors has changed though. While throughout this year we have been able to describe inflation as the number one enemy, this week inflation has been eclipsed by growth worries.

US business activity shrinks

This week, several US regional surveys showed declining business activity during June. Thursday’s release of personal income and spending data was a bit more dated, only covering May, but it showed the slowest pace of spending growth this year, even accounting for the downgrade to April’s growth. After adjusting for inflation, May also saw the first negative spending growth this year. That is despite income growing quite robustly. The art of interpreting economic data is always about deciding when there is enough data to imply a new trend is developing. With economic activity, it does seem like there is an increasing amount of data that suggests slowing activity.

A lot of this comes from surveys which provide the most up to date, but not always the most reliable, guide to activity. According to the University of Michigan, consumers consider the current conditions for purchases of cars, houses and large appliances to be the worst since the early 1980s, but the data also suggests conditions have been declining since the end of 2019 (during which time we have seen prices surging). The cost of home ownership has, however, risen to the point at which it seems likely that many prospective homeowners will have to abandon their plans to buy a property for now. Mortgage refinancings have also slowed as rising mortgage rates have reduced the ability of US homeowners to lower their monthly outgoings by refinancing their mortgages at a lower interest rate.

Recession risks

Federal Reserve chairman Jay Powell told an audience at the European Central Bank’s annual policy forum in Sintra that he believes the Fed can restrain growth while avoiding a recession. That’s a huge challenge bearing in mind that recessions are a somewhat inevitable consequence of the end of the business cycle. Recessions seem even more likely when the sharp increase in inflation requires an even sharper increase in interest rates.

A recession may even have already started, according to the Atlanta Fed’s GDPnow “nowcast”. This tries to measure how fast gross domestic product (GDP) is currently growing, without having to wait for the official estimates which come through weeks after the eventual end of the quarter. GDPnowsuggests that growth has slipped into negative territory. The series is very volatile, but if growth were negative for the quarter just ended then that would mark a second consecutive quarter of negative growth and would place the US in a recession. It would be an extraordinarily shallow recession, though, of the kind that we might label a technical recession because of the lack of real recessionary features – most notably we have not seen a sharp increase in unemployment.

For now, data still seems to suggest that the employment market is tight. There continue to be about two jobs for every one person looking for work. Most surveys find respondents recognising that jobs are plentiful, although increasingly respondents are anticipating the labour market turning more negative.

Commodity prices fall

Adding to the recessionary narrative have been drops in commodity prices, which have been declining for the past fortnight. The biggest pain has been in industrial metals, which do not have a big

or immediate impact on consumer price inflation, but wheat and oil prices have fallen back from their peaks a few weeks ago and that helps with the notion that inflation may be past its peak.

Oil is by far the most impactful factor for headline inflation – so much so that many policymakers strip it out of their figures to avoid being whipsawed by a volatile and unpredictable source of inflation. Oil was largely responsible for the unexpectedly high level of inflation during May, but the last few weeks make it easier to imagine that US inflation has moved past its peak rate. That comes despite OPEC failing to decisively increase oil supply at this week’s meeting; instead, they acknowledged the risk that they wouldn’t be able to make their current targets. Meanwhile, US negotiators provided a downbeat update on talks with Iran over ending its nuclear programme and potentially bringing its oil supply back to the market.

With recessionary risks perceived to be rising and commodities signalling that inflation is ebbing, money markets no longer see the trajectory of interest rates as being inexorably upwards. Instead, the peak in interest rates has begun to be discounted at the February 2023 interest rate setting meeting. So far, though, there has been no acknowledgement that the Fed will indeed reduce the pace at which it is hiking interest rates and until it does the market will remain anxious.