FLAHERTY & CRUMRINE TOTAL RETURN FUND INC. First-Quarter U.S. Economic Update
May 2022
Summary of Recent Economic and Market Developments
The U.S. economy was mixed in the first quarter, with overall real GDP down 1.4% but domestic final sales up 2.6%. Employment continued to rise briskly, the unemployment rate fell to 3.6%, and demand for workers remained strong. Personal income rose moderately, with solid gains in wages and salaries, but failed to keep pace with inflation. Nonetheless, real personal consumption expenditures rose 2.7% in Q1 as consumers dipped into savings and increased borrowing. Home sales slowed as higher prices and mortgage rates cooled demand, while high inflation turned strong nominal residential investment into only a 2.1% real gain. Industrial output rose strongly, up 7.6% in Q1, and capacity utilization reached its highest level since 2018. That prompted a 9.2% gain in business investment despite another small drop in structures investment. Trade (-3.2%), inventories (-0.8%), and government consumption (-0.5%) each made negative contributions to first quarter real GDP growth.
Inflation rose to the highest levels in 40 years, with the year-over-year CPI reaching a high of 8.5% in March and the PCE deflator touching 6.6% in March. Inflation broadened beyond food and energy prices, and the core (excluding food and energy) CPI rose to a peak 6.5% YoY in March, while the core PCE deflator reached its peak of 5.3% in February. While those levels probably mark the peak in inflation for this cycle, we do not expect to see major progress on inflation until the fourth quarter.
High inflation prompted a sharp turn in monetary policy. The Fed hiked the fed funds rate by 75 bp so far, and markets currently expect the funds rate to reach 2.75-3.00% by year-end, peaking around 3.25% in mid-2023. The Fed also ended quantitative easing in March and will begin to reduce its balance sheet in June. Yields on 10- and 30-year Treasuries rose by 126 and 109 bp, respectively, since the start of 2022, and credit spreads widened sharply as investor worries over recession mounted, leading to sizable negative returns so far in 2022. Although we anticipate a mild recession sometime after mid-2023, fundamental credit quality remains healthy. Leverage has continued to decline, while business bankruptcy filings, household and business debt service, and bank loan delinquencies and charge-offs all remain historically low. We think financial companies, which are the largest issuers in the preferred market, should benefit from higher interest rates and have the capital, earnings, and reserves to manage strains that a recession could bring. We believe today's higher yields on preferred and contingent capital securities offer a foundation for potentially better returns ahead.
Author's note: We changed the presentation of our Economic Update this quarter, organizing it by major economic sectors and markets. Most economic and market data now appear in tables and graphs, while accompanying prose focuses on explanation and analysis. In many data tables, we use green shading to highlight indicators that improved from the prior period, red shading on those that deteriorated, and no shading on indicators that were little changed. We hope you find the new format more readable and useful.
First-Quarter U.S. Economic Update | Page 1 | May 20, 2022 |
Economic Outlook
Figure 1: U.S. Gross Domestic Product
Real GDP (QoQ%, AR; *Q4/Q4) | Nominal GDP (QoQ%, AR; *Q4/Q4) | Implicit Deflator (AR; *Q4/Q4) | ||||||||||
Sector | 2022:1 | 2021:4 | 2021* | 2020* | 2022:1 | 2021:4 | 2021* | 2020* | 2022:1 | 2021:4 | 2021* | 2020* |
Gross Domestic Product (GDP) | -1.4% | 6.9% | 5.5% | -2.3% | 6.5% | 14.5% | 11.8% | -1.0% | 8.0% | 7.1% | 5.9% | 1.3% |
Personal Consumption Expenditures | 2.7% | 2.5% | 6.9% | -2.4% | 9.9% | 9.0% | 12.8% | -1.3% | 7.0% | 6.4% | 5.5% | 1.2% |
PCE: Goods | -0.1% | 1.1% | 7.3% | 7.7% | 11.6% | 11.4% | 16.1% | 7.2% | 11.8% | 10.2% | 8.2% | -0.5% |
PCE: Services | 4.3% | 3.3% | 6.7% | -6.9% | 9.0% | 7.8% | 11.1% | -5.1% | 4.6% | 4.4% | 4.1% | 2.0% |
Fixed Investment | 7.3% | 2.7% | 4.4% | 0.5% | 17.6% | 11.8% | 10.7% | 2.2% | 9.6% | 8.9% | 6.0% | 1.7% |
Business Investment | 9.2% | 2.9% | 6.6% | -3.8% | 16.7% | 11.0% | 10.2% | -3.0% | 6.8% | 7.8% | 3.4% | 0.8% |
Structures | -0.9% | -8.3% | -2.6% | -20.0% | 17.5% | 14.0% | 8.9% | -19.4% | 18.5% | 24.4% | 11.8% | 0.7% |
Equipment | 15.3% | 2.8% | 6.5% | -0.3% | 23.1% | 9.9% | 9.2% | -1.1% | 6.7% | 6.9% | 2.6% | -0.8% |
Intellectual Property | 8.1% | 8.9% | 11.5% | 2.5% | 9.8% | 10.6% | 12.0% | 5.3% | 1.7% | 1.6% | 0.4% | 2.7% |
Residential Investment | 2.1% | 2.2% | -1.5% | 15.7% | 20.2% | 14.4% | 11.9% | 21.0% | 17.8% | 11.9% | 13.6% | 4.6% |
Government Consumption | -2.7% | -2.6% | 0.1% | 1.2% | 6.1% | 4.8% | 6.4% | 3.0% | 9.1% | 7.6% | 6.3% | 1.8% |
Federal | -5.9% | -4.3% | -1.1% | 3.1% | 0.7% | 1.1% | 3.6% | 4.9% | 7.0% | 5.7% | 4.7% | 1.7% |
State & Local | -0.8% | -1.6% | 0.8% | 0.0% | 9.5% | 7.1% | 8.2% | 1.9% | 10.3% | 8.9% | 7.3% | 1.9% |
Domestic Final Sales | 2.6% | 1.7% | 5.3% | -1.3% | 10.6% | 8.8% | 11.3% | 0.1% | 7.8% | 7.0% | 5.7% | 1.4% |
Private Domestic Final Sales | 3.7% | 2.6% | 6.4% | -1.8% | 11.5% | 9.6% | 12.3% | -0.6% | 7.6% | 6.9% | 5.6% | 1.3% |
Legend for all Figures: AR = Annual Rate; SA = Seasonally Adjusted; MA = Moving Average; C.O.P. = Change over Period Data source for all tables is Macrobond, unless noted otherwise.
The U.S. economy turned in a mixed performance in the first quarter, with stronger domestic final sales but weaker overall growth (Figure 1). Inflation-adjusted gross domestic product (real GDP) slipped 1.4%, as slower inventory accumulation and a sharply wider trade deficit together subtracted 4.0% from Q1 growth. Nominal GDP rose strongly in most sectors, with federal government spending a notable exception. However, inflation worsened across most major sectors of the economy, reaching the highest levels in 40 years. After inflation, personal consumption expenditures and residential investment rose moderately, business investment jumped, and government consumption fell for the second consecutive quarter. This "stagflationary" combination of strong nominal growth, sticky inflation, and modest real growth is likely to remain a theme into 2023.
Economists expect real GDP growth to average 2.7% in 2022, with growth of 3.0% in Q2, 2.7% in Q3, and 2.2% in Q4 as tighter monetary policy dampens demand.1 While that growth rate would be down substantially from 2021, it would be more in line with its long-term trend of 2.0-2.5%. The outlook for 2023-24 is a much tougher call. Inflation and the Federal Reserve's response to it, developments in Ukraine, COVID's impact on global supply chains and consumer activity, and the midterm elections, are just a few of the challenges facing the economy next year. For now, economists expect 2.1% and 2.0% growth in 2023 and 2024, respectively. Those forecasts imply that the Fed will engineer an economic "soft landing" by reducing core PCE inflation (currently over 5%) close to its 2% long-term target while avoiding a recession. With such high inflation, that will be a very difficult task. We think a recession beginning in the second half of 2023 or in 2024 is more likely. However, we do not see over- investment in homes, inventories, or plant and equipment that typically lead from boom to bust. As a result, our anticipated recession should be mild.
- Bloomberg Monthly Economic Survey, May 13, 2022, Bloomberg L.P.
First-Quarter U.S. Economic Update | Page 2 | May 20, 2022 |
Employment, Income and Spending
Figure 2: Employment Overview
Employment | MoMΔ (Level for Rates) | QoQ Change | YoY% Change | Chg vs. | |||||
(Thousands except percents) | Apr-22Mar-22Feb-22 | 2022:1 | 2021:4 | 2021:3 | Apr-22Mar-22 | Feb-20 | |||
Nonfarm Payrolls | 428 | 428 | 714 | 1,646 | 1,912 | 1,630 | 4.6% | 4.5% | (1,190) |
Private | 406 | 424 | 704 | 1,620 | 1,882 | 1,544 | 5.2% | 5.0% | (500) |
Household Employment | (353) | 736 | 548 | 2,483 | 2,169 | 2,194 | 4.5% | 5.1% | (761) |
Labor Participation Rate % | 62.2% | 62.4% | 62.3% | 0.5% | 0.2% | 0.1% | 0.5% | 0.9% | -1.2% |
Unemployment Rate | 3.6% | 3.6% | 3.8% | -0.3% | -0.8%-1.2% | -2.4% | -2.4% | 0.1% | |
MoM% Change | QoQ% Change | YoY% Change | |||||||
Average Hourly Earnings | Apr-22Mar-22Feb-22 | 2022:1 | 2021:4 | 2021:3 | Apr-22Mar-22 | Feb-20 | |||
Average Hourly Earnings, All | 0.31% | 0.47% | 0.13% | 4.8% | 6.1% | 5.3% | 5.5% | 5.6% | 3.7% |
QoQ% Chg (not annualized) | YoY% Change | ||||||||
Employment Cost Index | 2022:1 | 2021:4 | 2021:3 | 2021:2 | 2022:1 | 2021:4 | 2021:3 | 2021:2 | 2019:4 |
Employment Cost, Total, Civilian | 1.4% | 1.0% | 1.2% | 0.8% | 4.5% | 4.0% | 3.7% | 2.9% | 2.7% |
The labor market added 1.65 million new jobs in the first quarter and another 428,000 in April, pushing the unemployment rate down to 3.6%, just 0.1% above its pre-pandemic level (Figure 2). While Q1 employment growth was down from 4Q2021's pace, it edged out Q3 and remained very strong. Employment as measured by the household survey was even stronger in Q1 at 2.48 million, although a decline in April left the payroll survey (2.07 million) and household survey (2.13 million) reporting similar gains so far in 2022. Payroll and household employment levels have rebounded to within roughly 1 million of their pre-pandemic peaks in February 2020. Considering that the payroll and household surveys recorded 22 and 25 million job losses, respectively, between February and April 2020, it has been a remarkable recovery that has driven significant gains in wage and salary income.
Figure 3: Strong Demand Boosting Wages
U.S. Wage Growth and Unemployment Rate | |||||||
15 | 9 | ||||||
14 | 8 | ||||||
13 | YoY | ||||||
12 | 7 | ||||||
Percent | 11 | 6 | orWage | ||||
Rate,Unemployment | 10 | 5.5 | PercentGrowth,Earnings | ||||
5 | |||||||
9 | 4.7 | ||||||
8 | 4 | ||||||
7 | 3 | ||||||
6 | |||||||
2 | |||||||
5 | |||||||
4 | 1 | ||||||
3.6 | |||||||
3 | 0 | ||||||
2017 | 2018 | 2019 | 2020 | 2021 | 2022 |
Employment Cost Index, Wages & Salaries, Civilian Workers, Total, Index, rhs [c.o.p. 1 year] Earnings, Average Hourly Earnings, Total Private, SA, USD, rhs [c.o.p. 1 year]
Unemployment, National, 16 Years & Over, Rate, SA, lhs
Source: Macrobond
Figure 4: Savings Keeping Spending Up
Nominal Personal Income, Consumption and Savings, YoY | ||||
35 | 30 | |||
25 | ||||
30 | 20 | |||
PercentGrowth,Spending& Income | ||||
PercentRate,Savings | 25 | 15 | ||
11.7 | ||||
9.1 | ||||
20 | 5 | |||
0 | ||||
15 | -5 | |||
-10 | ||||
10 | -11.6 | |||
-15 | ||||
6.2 | ||||
5 | -20 | |||
Jan Mar May Jul Sep Nov Jan | Mar May Jul Sep Nov | Jan Mar May | ||
2020 | 2021 | 2022 |
Total, Personal Saving Rate, lhs
Personal Outlays (PCE), Overall, Total, Current Prices, AR, SA, USD, rhs [c.o.p. 12 months] Income Approach, Employee Wages & Salaries, Total, SA, AR, USD, rhs [c.o.p. 12 months]
Personal Income, Total, USD, rhs [c.o.p. 12 months]
Source: Macrobond
First-Quarter U.S. Economic Update | Page 3 | May 20, 2022 |
Prospects for continued job growth-and higher wages-remain bright, although the current pace of job gains is bound to slow. Demand for labor remains strong, with over 11.5 million job openings in March, or more than 1.9 open positions for every unemployed person. The problem is a lack of workers. The labor force has grown by only about 2% over the past year, compared to a 4.6% jump in payroll jobs. Although labor participation has been rising, it remains below pre-pandemic levels (Figure 2), and many people who left the labor force may not return. Without more workers, job openings will remain unfilled, leading to bidding wars as employers compete for talent. Wages and salaries have risen significantly over the past year and are rising faster than when unemployment was at a similar level before the pandemic (Figure 3). Although higher wages are desirable, they can be inflationary if not accompanied by productivity growth. Unfortunately, productivity dropped substantially in Q1, boosting unit labor costs considerably (up 7.2% YoY in Q1). With economic growth likely to slow this year, we expect this imbalance will be resolved by a slower pace of hiring that should first stabilize wage growth and, eventually, bring labor costs back down to levels consistent with long-term labor productivity growth.
Figure 5: Personal Income and Spending
Personal Income and | MoM Change | QoQ Change | YoY Change | ||||||
Consumption | Mar-22Feb-22Jan-22 | 2022:1 2021:4 2021:3 | 2022:1 2021:4 2021:1 | ||||||
Personal Income | 0.51% | 0.73% | 0.18% | 5.2% | 2.4% | 3.0% | -3.0% | 7.2% | 16.1% |
Wages & Salaries | 0.58% | 1.05% | 0.51% | 8.9% | 10.9% | 12.6% | 11.3% | 10.0% | 2.9% |
Real Disposable Pers. Inc. | -0.38% | 0.15% | -0.27% | -2.0% | -5.6% | -4.1% | -10.9% | -0.2% | 15.1% |
ex Transfer Payments | -0.30% | 0.38% | -0.14% | -0.1% | 1.4% | 3.2% | 2.4% | 1.9% | -0.1% |
Nominal PCE | 1.11% | 0.62% | 2.05% | 9.9% | 9.0% | 7.4% | 11.3% | 12.8% | 3.9% |
excl. Food & Energy | 0.67% | 0.59% | 1.97% | 8.7% | 8.3% | 6.6% | 10.7% | 12.0% | 3.7% |
Goods | 1.22% | 0.27% | 4.52% | 11.6% | 11.4% | -2.1% | 10.7% 16.1% 15.8% | ||
Services | 1.05% | 0.81% | 0.77% | 9.0% | 7.8% | 12.9% | 11.6% | 11.1% | -1.5% |
Real PCE | 0.24% | 0.10% | 1.51% | 2.7% | 2.5% | 2.0% | 4.7% | 6.9% | 2.1% |
Personal income grew strongly in nominal terms in Q1, but high inflation pushed real disposable personal income growth into negative territory (Figure 5). Much of the weakness in income compared to prior periods is attributable to the end of pandemic-related transfer payments. Excluding transfers, real disposable personal income was up modestly last year and was about flat in Q1. As noted earlier, wage and salary income rose briskly and was a key support to spending (Figure 4). After inflation, however, even those gains were modest.
Nominal personal consumption expenditure (PCE) was very strong in the first quarter, with solid growth in both goods and services (Figures 4 & 5). While inflation took its toll, real PCE growth accelerated over the past several quarters. US consumers see rising wages and high job availability, and they are spending. However, high inflation, weak financial markets, and worries over war in Ukraine have pushed consumer confidence down sharply. The University of Michigan's preliminary consumer sentiment survey for May revealed confidence at levels usually seen in or near a recession (Figure 6). Nevertheless, a parallel survey from the Conference Board, which has not yet been released for May, has shown less deterioration in confidence. So far, weaker confidence has not dented spending. Overall and core "retail
First-Quarter U.S. Economic Update | Page 4 | May 20, 2022 |
control" categories of retail sales rose 0.9% and 1.0% (not annualized), respectively, in April. Adjusting those nominal sales for inflation using the CPI deflator, they are up 5.8% and 3.9%, respectively, at an annual rate compared to the Q1 average, leaving spending off to a strong start in Q2. For now, we expect continued moderate gains in PCE, albeit at a slowing pace from mid-year as Fed tightening begins to dampen demand and job growth slows.
Figure 6: Consumer Confidence Down, Out?
United States, Consumer Surveys (Gray bar = NBER recession)
150
140
130
120
110
107.3
100 | ||
Index | 90 | |
80 | ||
70 | ||
60 | 59.1 | |
50 |
40
30
20
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
Conference Board, Consumer Confidence Index, Total, Total, SA
University of Michigan, Consumer Sentiment, Consumer Sentiment
Source: Macrobond
Figure 7: Credit Card Borrowing Surging
U.S. Consumer Credit Growth by Major Borrowing Category | ||
30 | ||
23.2 | ||
20 | ||
10 | 10.0 | |
6.2 | ||
Percent | 0 | |
-10 | ||
-20 | ||
-30 | ||
-40 |
Jan May Sep | Jan May Sep | Jan May Sep | Jan May Sep | Jan May |
2018 | 2019 | 2020 | 2021 | 2022 |
Total, Level, Total Outstanding [a.r. 3 months]
By Major Types of Credit, Level, Revolving, Total [a.r. 3 months]
By Major Types of Credit, Level, Nonrevolving, Total [a.r. 3 months]
Source: Macrobond
Given modest real income growth, real spending gains were enabled by reduced savings and, increasingly, borrowing. The personal saving rate declined to 6.2% in March and an average of 6.6% in Q1, slightly below the pre-pandemic rate of about 7% (Figure 4). Consumers are still sitting on large saving buffers accumulated during the pandemic, when spending slumped. It is not surprising that they are spending down those savings now, especially when prices of essential items like housing, food, and energy have risen quickly.
Those savings are not unlimited, though, and it appears that some consumers have turned to credit card borrowing to support spending. Revolving credit balances rose at a 23.2% annualized rate over three months ending in March, up sharply since year-end and far above an average of about 4% in 2018 and 2019 (Figure 7). While aggregate consumer balance sheets remain healthy, with low ratios of household debt-to-GDP and interest expense-to- income, the recent acceleration in credit card borrowing could be an early sign of broader strain from rising living costs. We will be watching both consumer confidence and growth in consumer credit over coming months.
First-Quarter U.S. Economic Update | Page 5 | May 20, 2022 |
This is an excerpt of the original content. To continue reading it, access the original document here.
Attachments
- Original Link
- Original Document
- Permalink
Disclaimer
Flaherty & Crumrine Total Return Fund Inc. published this content on 20 May 2022 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 24 May 2022 15:58:03 UTC.
