Thoughts

September 09, 2022 | 14:25

U.S. Economy Shakes Off Summertime Blues

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

One reason the Fed is still pounding the tightening drum is that the economy might be getting a second wind. Growth may have rebounded to an above-potential rate this quarter—the exact opposite of what the Fed wants. To rebalance supply and demand and cool inflation pressures, the economy needs to grow less than potential, pegged at a little under 2%. But some recent data now suggest it could rebound upwards of 2% in the third quarter following successive declines in real GDP. These include a surprising upturn in the ISM services gauge, strength in aggregate work hours, and a solid increase in the New York Fed’s Weekly Economic Index. Perkier activity would explain the surprising retreat in initial jobless claims to 222,000 from July’s cycle-peak of 261,000.

The economy is getting an unexpected lift from trade, as the real goods deficit narrowed sharply in July due to a surprising jump in exports. As well, the tourism industry has enjoyed a late-summer surge in personal travel and pickup in business trips. Cheaper gasoline is also putting a few extra bucks in people’s pockets. While auto sales remain stuck in low gear, demand for luxury vehicles remains strong amid improved inventories of expensive high-margin models.

Not all indicators are tilted upward, though. Data from S&P Global suggest the service sector might actually have shrunk last month, and at a faster rate than in July, which is the exact opposite of what the ISM survey shows. As well, the Atlanta Fed’s GDPNow model currently pencils in just 1.4% growth for the current quarter, only modestly above our call of 0.6%.

While we may need to nudge up our growth estimate for the third quarter, there’s no need to turn bullish on the general outlook. The Fed’s tough talk has sent 30-year fixed mortgage rates back to 14-year highs of 5.9%, which will only slam the housing market harder. As well, the Beige Book notes that businesses expect “further softening of demand over the next six to twelve months”. Most importantly, policymakers are leaning against firmer growth, with Chair Powell saying the Fed needs to act “forthrightly” to deal with inflation. Therefore, we still see the economy stalling in Q4, contracting in Q1, and expanding only modestly next year. The slump will raise the jobless rate, cool wages, and put inflation on a sustained downhill trek. These are the minimum requirements for the Fed to stop tightening and for the economy to avoid a meaningful recession.