US - Pipeline pressures are cooling, but inflation itself is still hot
GDP revisions show that the Covid recession was shallower, and the recovery stronger than initially estimated. This suggests less room for further recovery than we thought. Labour market data points to softening demand. Other pipeline inflationary pressures are also easing. However, core inflation is likely to remain alarmingly high for the next few months. The Fed will continue raising rates aggressively, with near-term rate risks tilted to the upside.
The Bureau of Economic Analysis made significant revisions to GDP data on 29 September, which showed that the Covid recession was shallower – and the recovery stronger – than initially thought: 2020 GDP growth was revised up to -2.8% from -3.4%, and 2021 to 5.9% from 5.7%. In particular, services consumption is now estimated to have a significantly smaller gap with trend of 2.7pp as of August, compared to 4.2pp previously. While positive news from a backward-looking perspective, there is one important negative implication for the future: the room for growth in the services sector now looks a lot less than it used to. As a result, while the revisions would ordinarily have led us to raise our GDP forecast, we keep our 2022 growth forecast unchanged at 1.7%, and downgrade our 2023 expectation to 0.7% from 1.0% previously. In quarterly terms, Q3 GDP rebounded from the contractions seen in the first half of the year by 2.6% annualised, driven largely by strength in net exports (domestic demand continued to contract). We look for a renewed decline in output in Q4 as falling goods consumption offsets an increasingly tepid services recovery. All in all, we continue to expect a mild recession next year, with an expected 1.5pp rise in the unemployment rate likely to meet the NBER definition of a downturn.
As well as showing stronger services consumption, the GDP revisions also suggest durable goods consumption was running even hotter than thought – at around 16% above trend in 2021 compared with 14% previously. This helps to further explain the surge in goods inflation in 2021. By the same turn, the significant cooling in goods consumption in 2022 is now helping to drive down goods inflation, which has increasingly taken a back seat to firming services inflation over the past few months. Declines in wholesale used car prices, the strong dollar, and an easing in a range of supply-side bottlenecks is likely to lead to a further normalisation in goods inflation over the coming months – and perhaps even outright goods deflation. Outside of goods, other pipeline inflationary pressures are also easing. In particular, the labour market now looks to be cooling, with job vacancies falling by a massive 1.1mn in August – the biggest decline in a single month outside of the depths of the pandemic in April 2020. While jobs growth remains solid for the time being, we expect rising unemployment combined with falling job vacancies to drive a sharp decline in the job vacancy ratio over the coming year.
Despite the broad easing in pipeline inflationary pressure, inflation itself has continued to surprise to the upside, with services price growth hitting a new 40 year high in September. Core inflation is expected to remain alarmingly high over the coming months, with shelter inflation likely to accelerate further in the near term. While our base case is for headline inflation to fall sharply in early 2023, red-hot services inflation suggests upside risks to our near term forecast for Fed rate hikes. We think the Fed will be confident it has done enough to tighten monetary policy by the end of the year, when the fed funds rate is expected to reach 4.25-4.50%. But it will very much depend on the data.