FLAHERTY & CRUMRINE TOTAL RETURN FUND INC. First-Quarter U.S. Economic Update
June 2023
Summary of Recent Economic and Market Developments
Real GDP growth in the U.S. slowed to 1.3% in the first quarter, but the composition of GDP improved, with acceleration in personal consumption and government spending helping lift domestic final sales to 3.3% from 0.7% in Q4. Hiring remained very strong during the quarter and in the April-May period. Average hourly earnings growth slowed, but the employment cost index showed little to no improvement. Real personal consumption expenditures jumped on a strong rebound in goods spending, while services spending remained firm. Home sales rose after falling by nearly one-third in 2022, which translated to a more- moderate decline in residential investment. Industrial output and orders fell in Q1 but rebounded in April. Real business investment growth slowed as capital equipment spending sagged. Trade, inventories, and government consumption together reduced real GDP growth by 1.2%. That left first-quarter private domestic final sales up 2.9%, up from zero in Q4.
Inflation data was mixed in the first quarter, with energy prices down and food inflation a little slower, but services inflation little changed and goods inflation up modestly. Year-over- year CPI rose 5.8% in Q1, down from 7.1% in Q4, and the PCE deflator slowed to 4.9% from 5.7% YoY over the same periods. Core inflation (excluding volatile food and energy prices) again showed little improvement. Core CPI rose 5.0% YoY and the core PCE deflator rose 4.7% in Q1, each down only 0.1% from the prior quarter. Moreover, inflation picked up again in April. We remain confident that goods inflation will slow as supply chain disruptions ease. Services inflation, however, remains sticky. Given a tight labor market and poor productivity, employment costs have remained high. Interest rates are now restrictive, and shrinking money supply suggests disinflationary pressure is building, but it may take some time for core inflation to fall more rapidly.
The Federal Reserve continued to tighten monetary policy, raising the fed funds target range by 25 bp at each of its three FOMC meetings so far this year. Market forward rates currently price in one more 25 bp rate hike in July, with rate cuts starting in late 2023 and a fed funds rate of 3.25% at year-end 2024, down from 5.00-5.25% currently. Yields on intermediate-term Treasuries fell modestly in Q1 but gave back about half of that rally since quarter-end. Credit spreads were mostly wider in the first quarter but have tightened modestly so far in Q2.
We see significant crosscurrents in the economy today, with some sectors remaining firm while others have weakened. We expect a downshift in growth that leads to a mild recession beginning in Q4, but there is risk that the economy and inflation will run hot and require considerably tighter monetary policy to dampen inflation. As a result, interest rate volatility is likely to remain elevated. However, we think the economy's trajectory will become clearer and risks around growth and inflation will diminish as year-end approaches. With yields up sharply from a year ago, fixed income investors do not need lower rates to earn good returns. Expect an eventful summer.
First-Quarter U.S. Economic Update | Page 1 | June 5, 2023 |
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 | 2023:1 | 2022:4 | 2022* | 2021* | 2023:1 | 2022:4 | 2022* | 2021* | 2023:1 | 2022:4 | 2022* | 2021* |
Gross Domestic Product (GDP) | 1.3% | 2.6% | 0.9% | 5.7% | 5.4% | 6.6% | 7.3% | 12.2% | 4.1% | 3.9% | 6.4% | 6.1% |
Personal Consumption Expenditures | 3.8% | 1.0% | 1.7% | 7.2% | 8.1% | 4.8% | 7.5% | 13.2% | 4.2% | 3.7% | 5.7% | 5.7% |
PCE: Goods | 6.3% | -0.1% | -0.8% | 7.1% | 7.1% | -0.6% | 5.4% | 15.6% | 0.7% | -0.5% | 6.2% | 7.9% |
PCE: Services | 2.5% | 1.6% | 3.0% | 7.2% | 8.6% | 7.7% | 8.5% | 12.0% | 6.0% | 6.0% | 5.4% | 4.5% |
Fixed Investment | -0.2%-3.8%-2.0% | 3.7% | 4.7% | 0.0% | 5.8% | 9.8% | 4.9% | 4.0% | 8.0% | 5.9% | ||
Business Investment | 1.4% | 4.0% | 4.5% | 5.0% | 8.3% | 7.7% | 11.4% | 8.5% | 6.9% | 3.6% | 6.6% | 3.3% |
Structures | 11.0% | 15.8% | -1.7% | -5.2% | 18.9% | 24.7% | 13.4% | 4.7% | 7.1% | 7.7% | 15.4% | 10.4% |
Equipment | -7.0% | -3.5% | 3.9% | 4.7% | 0.0% | 2.4% | 11.4% | 7.2% | 7.5% | 6.1% | 7.2% | 2.4% |
Intellectual Property | 5.2% | 6.2% | 8.2% | 10.8% | 11.7% | 5.5% | 10.5% | 11.6% | 6.1% | -0.6% | 2.2% | 0.7% |
Residential Investment | -5.4%-25.1%-18.8% | -0.3% | -6.7% | -21.3%-9.3% 13.6% | -1.4% | 5.1% | 11.7% | 13.9% | ||||
Government Consumption | 5.2% | 3.8% | 0.9% | 0.5% | 7.1% | 7.5% | 7.7% | 7.3% | 1.9% | 3.6% | 6.8% | 6.7% |
Federal | 7.6% | 5.8% | 0.1% | 0.4% | 11.4% | 9.2% | 5.0% | 4.6% | 3.5% | 3.2% | 4.9% | 4.3% |
State & Local | 3.8% | 2.6% | 1.3% | 0.6% | 4.7% | 6.6% | 9.4% | 9.0% | 0.9% | 3.9% | 8.0% | 8.3% |
Domestic Final Sales | 3.3% | 0.7% | 0.9% | 5.4% | 7.4% | 4.4% | 7.2% | 11.6% | 3.9% | 3.8% | 6.3% | 5.9% |
Private Domestic Final Sales | 2.9% | 0.0% | 0.9% | 6.4% | 7.4% | 3.8% | 7.1% | 12.5% | 4.3% | 3.8% | 6.2% | 5.7% |
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. Green (red) shading denotes improving (worsening) values.
U.S. economic growth slowed in the first quarter, but the composition of growth improved. Gross domestic product after inflation (real GDP) rose by 1.3%, half the pace of 4Q2022 (Figure 1). Real personal consumption expenditure made the largest contribution to GDP growth in the first quarter, led by a 6.3% surge in goods spending. Real residential investment declined again but at a much slower pace than last year. Business investment also slowed, driven by a 7.0% drop in business equipment spending, while investment in business structures had another double-digit gain. Real government consumption accelerated, with gains in both state and local and federal government spending. Trade was neutral to growth in Q1, but a sharp slowdown in inventory accumulation subtracted 2.1% from real GDP. Stronger consumer spending and less-bad residential investment were only partially offset by slower business investment, leaving domestic final sales up 3.3%. The implicit deflator edged up in most major sectors of the economy in the first quarter, although it is down considerably from its overall pace in 2022.
Looking ahead, economists expect GDP growth to turn slightly negative in 4Q2023 (a quarter later than previously) but do not expect a recession over a 3-year forecast horizon. The most recent Survey of Professional Forecasters shows a median forecast for U.S. real GDP growth of 1.0% in Q2, 0.6% in Q3, slight contraction in Q4 (-0.1%), and an average growth rate of 1.0% in 2024.1 Core inflation is forecast to fall below 3.0% around the end of this year, and average about 2.5% in 2024 before arriving at or near the Fed's 2.0% target in 2025.
Our base-case economic outlook is largely the same as we described in our last Update.2 We continue to think nominal GDP growth will slow over 2023 as consumers deplete savings from the pandemic and reduce spending, but resilient employment and gradually falling inflation should allow real GDP to expand modestly through Q3. Eventually, however, we think tight
- Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters, May 12, 2023.
- Flaherty & Crumrine Fourth-QuarterU.S. Economic Update, February 13, 2023.
First-Quarter U.S. Economic Update | Page 2 | June 5, 2023 |
monetary policy will push up unemployment, and consumer spending will stall. Residential investment, which has been hit hard by higher interest rates, should continue to contract, albeit at a slowing pace throughout the year. Business investment is off to a weaker start than we expected as businesses reduced capital equipment spending given poor returns on earlier investments-productivity has been falling on a 4-quarter annual basis since the start of 2022. With borrowing costs up significantly, we expect business investment will turn negative in the second half of this year. In addition, the recent debt ceiling deal is poised to slow federal government spending modestly beginning in Q4. By the fourth quarter of 2023, we think the economy will be in a mild recession.
However, with growth remaining resilient in the face of sharply higher interest rates, core inflation has declined only gradually. Services inflation has shown tentative signs of slowing recently, but goods inflation has edged up. We expect goods inflation to slow again soon, and certain services components, notably housing, also appear to be slowing. The Fed has been banking on slower job growth and higher unemployment to slow wage growth, but job growth remains strong and employment costs stubbornly high. That suggests service inflation could remain elevated. Under our base case, we think the Fed is within 25 bp of its "terminal" rate for this cycle, but it may need to go higher if inflation does not cooperate. Even in our base case, we think the Fed will leave rates at the terminal rate longer than markets currently expect, reflecting the resilience of growth and inflation.
We think these crosscurrents-with some parts of the economy still looking firm (employment, the unemployment rate, services spending, and inflation) while others look weak (manufacturing orders and capital expenditure, foreign trade volumes, leading economic indices, and consumer and business sentiment)-suggest the economy is at a turning point. We think that means a downshift in growth that leads to a mild recession beginning late this year. However, it could mean businesses and consumers are adapting to higher inflation and will continue to spend and invest, keeping the economy tight and inflation running hot. Data support both outlooks to varying degrees. If our base case is right, the Fed should be nearly finished tightening. If it is not, there may be considerably more tightening ahead.
With the path of growth and inflation still uncertain, we expect interest rate volatility to remain elevated. Nonetheless, we think the economy's trajectory will become clearer and risks around growth and inflation will diminish as year-end approaches. With yields up sharply from a year ago, fixed income investors do not need lower rates to earn good returns. Expect an eventful summer.
First-Quarter U.S. Economic Update | Page 3 | June 5, 2023 |
Employment, Income and Spending
Figure 2: Employment Overview
Employment | MoMΔ (Level for Rates) | QoQ Change | YoY% Change | Chg vs. | |||||
(Thousands except percents) | May-23Apr-23Mar-23 | 2023:1 2022:4 2022:3 | May-23Apr-23 | Feb-20 | |||||
Nonfarm Payrolls | 339 | 294 | 217 | 937 | 853 | 1,270 | 2.7% | 2.7% | 3,734 |
Private | 283 | 253 | 157 | 703 | 759 | 1,143 | 2.7% | 2.8% | 3,943 |
Household Employment | (310) | 139 | 577 | 1,648 | 394 | 793 | 1.5% | 2.0% | 1,972 |
Labor Participation Rate % | 62.6% | 62.6% | 62.6% | 0.3% | 0.0% | 0.1% | 0.3% | 0.4% | 0.0% |
Unemployment Rate | 3.7% | 3.4% | 3.5% | 0.0% | 0.0% | -0.1% | 0.1% | -0.2% | 0.0% |
MoM% Change | QoQ% Change, AR | YoY% Change | |||||||
Average Hourly Earnings | May-23Apr-23Mar-23 | 2023:1 2022:4 2022:3 | May-23Apr-23 | Feb-20 | |||||
Average Hourly Earnings, All | 0.33% | 0.39% | 0.27% | 3.4% | 4.9% | 4.4% | 3.6% | 5.1% | 3.7% |
QoQ% Chg (not annualized) | YoY% Change | ||||||||
Employment Cost Index | 2023:1 | 2022:4 | 2022:3 | 2022:2 | 2023:1 2022:4 2022:3 2022:2 | 2019:4 | |||
Wages & Salaries, Civilian | 1.2% | 1.2% | 1.3% | 1.3% | 5.0% | 5.1% | 5.1% | 5.3% | 2.9% |
The labor market remains remarkably strong for an economy finishing its third year of expansion (Figure 2). Job growth accelerated in the first quarter, and the unemployment rate averaged 3.5%, the lowest quarterly figure since 1969. Jobs rose briskly in April too. Average hourly earnings did slow in Q1, but that reflects outsized gains in lower-wage employment. The employment cost index of wages and salaries, which corrects for the composition of jobs, was essentially unchanged at 5.0% YoY in Q1 (Figure 3). Both measures of wage inflation are down from their 2022 peaks, but they remain far too high given a 2% inflation target. The quit rate continued its slide, and job openings mostly declined, although they rose again in April (Figure 4). Despite these crosscurrents, we expect labor market conditions will loosen and help slow wage growth over coming quarters. Job and, especially, wage growth will be key data points for policymakers at the Federal Reserve over the second half of 2023.
Figure 3: High Labor Demand and Wages… | Figure 4: …but Fewer Job Openings and Quits |
U.S. Wage Growth and Unemployment Rate | JOLTS Quit Rate and Job Openings to Unemployment Ratio |
15 | 9 | 3.50 | 2.25 | |||||||||||||
14 | 8 | |||||||||||||||
3.25 | 2.00 | |||||||||||||||
13 | ||||||||||||||||
12 | 7 | YoY | 1.79 | |||||||||||||
3.00 | ||||||||||||||||
Unemployment Rate, Percent | Wage or Earnings Growth,Percent | |||||||||||||||
11 | 6 | 1.50 | Openings/Umemployment, Ratio | |||||||||||||
10 | 2.75 | |||||||||||||||
5.0 | 2.7 | |||||||||||||||
9 | 4.3 | 1.25 | ||||||||||||||
2.50 | ||||||||||||||||
8 | 4 | |||||||||||||||
1.00 | ||||||||||||||||
7 | 3 | 2.25 | ||||||||||||||
6 | 2 | Rate,Quit% | 0.75 | |||||||||||||
2.00 | ||||||||||||||||
5 | 0.50 | |||||||||||||||
1 | ||||||||||||||||
4 | ||||||||||||||||
3.7 | ||||||||||||||||
1.75 | ||||||||||||||||
3 | 0.25 | |||||||||||||||
0 | ||||||||||||||||
2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 1.50 | |||||||||
Employment Cost Index, Wages & Salaries, Civilian Workers, Total, Index, rhs [c.o.p. 1 year] | 0.00 | |||||||||||||||
2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | ||||||||||
Earnings, Average Hourly Earnings, Total Private, SA, USD, rhs [c.o.p. 1 year] | ||||||||||||||||
Unemployment, National, 16 Years & Over, Rate, SA, lhs | Labor Turnover, Quits, Nonfarm, Private, Total, Rate, lhs | Job Openings/Unemployed Persons, rhs | ||||||||||||||
Source: Macrobond | Source: Macrobond |
First-Quarter U.S. Economic Update | Page 4 | June 5, 2023 |
Figure 5: Personal Income and Spending
Personal Income and | MoM Change | QoQ Change (AR) | YoY Change | ||||||
Consumption | Apr-23Mar-23Feb-23 | 2023:1 2022:4 2022:3 | 2023:1 2022:4 2022:1 | ||||||
Personal Income | 0.36% | 0.28% | 0.33% | 4.6% | 5.0% | 7.5% | 5.5% | 5.1% | -3.5% |
Wages & Salaries | 0.47% | 0.27% | 0.22% | 4.6% | 1.9% | 11.4% | 5.7% | 6.2% | 10.9% |
Real Disposable Pers. Inc. | 0.04% | 0.24% | 0.18% | 7.8% | 2.5% | 3.2% | 2.8% | -1.9% | -12.8% |
ex Transfer Payments | 0.16% | 0.21% | -0.06% | 0.3% | 0.0% | 4.4% | 0.8% | 0.1% | 2.0% |
Nominal PCE | 0.84% | 0.08% | 0.13% | 8.1% | 4.8% | 6.7% | 7.3% | 7.5% | 11.5% |
excl. Food & Energy | 0.96% | 0.09% | 0.04% | 9.9% | 5.3% | 8.0% | 7.8% | 7.3% | 11.0% |
Goods | 1.07% | -0.76% | -0.10% | 7.1% | -0.6% | 2.4% | 4.1% | 5.4% | 11.0% |
Services | 0.72% | 0.50% | 0.24% | 8.6% | 7.7% | 9.0% | 8.9% | 8.5% | 11.8% |
Real PCE | 0.47% | -0.02% | -0.18% | 3.8% | 1.0% | 2.3% | 2.3% | 1.7% | 4.8% |
Personal income slowed in nominal terms in Q1, but real disposable personal income jumped 7.8% as cost-of-living adjustments boosted monthly Social Security payments by almost 10% starting in January (Figure 5). Sturdy job and wage growth translated to solid gains in wage and salary income, while higher transfer payments supported overall personal income (Figure 6). Although we expect nominal income growth to moderate as employment and wages cool, real incomes should benefit from lower inflation, especially next year.
Figure 6: Income and Spending Resilient | Figure 7: Leading Index Still Flashing Recession |
Nominal Personal Income, Consumption and Savings, YoY
35 | 35 | |||
30 | ||||
30 | 25 | |||
Income & Spending Growth, Percent | ||||
25 | 20 | |||
Savings Rate, Percent | ||||
15 | ||||
20 | 6.7 | |||
5.6 | ||||
15 | 5.4 | |||
0 | ||||
10 | -5 | % | ||
-10 | ||||
5 | 4.1 | |||
0 | -20 | |||
Jan Apr Jul Oct Jan Apr | Jul | Oct Jan Apr Jul | Oct Jan Apr |
2020 | 2021 | 2022 | 2023 |
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]
United States, Leading Indicators, Conference Board, Business Cycle Indicators, Composite Indexes-Leading Economic Indicators, Composite Index of 10 Leading Indicators, SA, Index [lag 6 obs, a.r. 6 months]
20 | |||||||||||||
15 | |||||||||||||
10 | |||||||||||||
5 | |||||||||||||
0 | |||||||||||||
-2.50 | |||||||||||||
-5 | |||||||||||||
-10 | -8.69 | ||||||||||||
-15 | |||||||||||||
-20 | |||||||||||||
-25 | |||||||||||||
1960 | 1965 | 1970 | 1975 | 1980 | 1985 | 1990 | 1995 | 2000 | 2005 | 2010 | 2015 | 2020 | 2025 |
Source: Macrobond | Source: Macrobond |
Nominal personal consumption expenditure (PCE) jumped 8.1% in the first quarter as good job growth, higher transfer payments, and mild weather spurred a nearly 2% gain in spending in January (Figure 5). Goods spending lagged services, but both rose impressively over the quarter. Following January's blowout, nominal spending slowed in February and March, leaving real spending negative in those months. Accompanied by lower consumer confidence surveys, it appeared that PCE was finally downshifting. However, higher retail sales and continued rapid job growth supported another strong start to the current quarter, with real PCE up 0.5% (not annualized) in April. So far, consumer spending has seen little impact from
First-Quarter U.S. Economic Update | Page 5 | June 5, 2023 |
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Flaherty & Crumrine Total Return Fund Inc. published this content on 05 June 2023 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 07 June 2023 17:05:09 UTC.
