FLAHERTY & CRUMRINE TOTAL RETURN FUND INC. Second-Quarter U.S. Economic Update
August 2023
Summary of Recent Economic and Market Developments
Real GDP grew 2.4% in the second quarter and 2.2% in the first half, both better than prior expectations. Employment gains slowed and job openings declined but remain elevated. Real personal consumption expenditures slipped to 1.6% in Q2 from 4.2% in Q1 on a big drop in goods spending and a modest pullback in services. Home sales fell after a strong rebound in Q1, and residential investment continued to shrink. Industrial output rose slightly but core order growth remained negative after inflation. Real business investment rose substantially as capital equipment spending rebounded and structures investment remained strong. The GDP contributions from trade and inventories netted to zero, while government consumption grew moderately. Private domestic final sales rose 2.3%, down from 3.2% in Q1.
Inflation finally showed signs of broad-based improvement in the second quarter. Goods inflation slowed, and services inflation showed tentative signs of cooling over the last several months. However, a tight labor market and still-strong demand for workers drove only a limited slowdown in wage growth to around 4.5%, which is too high to be consistent with a 2% inflation target. We anticipate that moderating economic and employment growth will dampen wage gains, allowing service prices to slow gradually.
The Federal Reserve continued to tighten monetary policy but slowed the pace of its actions. With the fed funds target currently 5.25-5.50%, market forward rates price in about a 40% chance of one more 25 bp rate hike and rates holding that plateau into 2Q2024. The market expects rate cuts will begin during that quarter. Treasury yields rose and the yield curve steepened as the market priced in a "higher for longer" rate view and prospects for more Treasury debt supply. Credit spreads tightened as banking turmoil diminished, but higher Treasury rates left preferred yields flat to moderately higher.
We continue to expect a downshift in growth that leads to a mild recession starting in Q4, gradually falling inflation, and rate cuts beginning around mid-2024. Of course, there is risk that economic growth remains resilient and inflation improvement stalls or reverses. That would likely prompt additional Fed tightening and higher yields. Nonetheless, short- and long-term interest rates have risen considerably in recent months, and they are close to our own forecasts now. Consequently, we think today's yields may offer an attractive entry point for long-term investors.
Second-Quarter U.S. Economic Update | Page 1 | August 15, 2023 |
Economic Outlook
Figure 1: U.S. Gross Domestic Product
Sector
Gross Domestic Product (GDP)
Personal Consumption Expenditures
PCE: Goods
PCE: Services
Fixed Investment
Business Investment
Structures
Equipment
Intellectual Property
Residential Investment
Government Consumption
Federal
State & Local
Domestic Final Sales
Private Domestic Final Sales
Real GDP (QoQ%, AR; *Q4/Q4) | |||
2023:2 | 2023:1 | 2022* | 2021* |
2.4% | 2.0% | 0.9% | 5.7% |
1.6% | 4.2% | 1.7% | 7.2% |
0.7% | 6.0% | -0.8% | 7.1% |
2.1% | 3.2% | 3.0% | 7.2% |
4.9% | -0.4% | -2.0% | 3.7% |
7.7% | 0.6% | 4.5% | 5.0% |
9.7% | 15.8% | -1.7% | -5.2% |
10.8% | -8.9% | 3.9% | 4.7% |
3.9% | 3.1% | 8.2% | 10.8% |
-4.2% | -4.0% | -18.8% | -0.3% |
2.6% | 5.0% | 0.9% | 0.5% |
0.9% | 6.0% | 0.1% | 0.4% |
3.6% | 4.4% | 1.3% | 0.6% |
2.3% | 3.5% | 0.9% | 5.4% |
2.3% | 3.2% | 0.9% | 6.4% |
Nominal GDP (QoQ%, AR; *Q4/Q4) | |||
2023:2 | 2023:1 | 2022* | 2021* |
4.7% | 6.1% | 7.3% | 12.2% |
4.3% | 8.4% | 7.5% | 13.2% |
1.1% | 6.8% | 5.4% | 15.6% |
6.0% | 9.3% | 8.5% | 12.0% |
5.7% | 4.4% | 5.8% | 9.8% |
8.9% | 7.8% | 11.4% | 8.5% |
13.5% | 25.8% | 13.4% | 4.7% |
9.2% | -2.0% | 11.4% | 7.2% |
6.4% | 9.4% | 10.5% | 11.6% |
-4.8% | -6.3% | -9.3% | 13.6% |
3.0% | 6.7% | 7.7% | 7.3% |
3.5% | 9.4% | 5.0% | 4.6% |
2.7% | 5.1% | 9.4% | 9.0% |
4.3% | 7.5% | 7.2% | 11.6% |
4.6% | 7.6% | 7.1% | 12.5% |
Implicit Deflator (AR; *Q4/Q4) | |||
2023:2 | 2023:1 | 2022* | 2021* |
2.2% | 4.0% | 6.4% | 6.1% |
2.6% | 4.1% | 5.7% | 5.7% |
0.4% | 0.7% | 6.2% | 7.9% |
3.8% | 5.9% | 5.4% | 4.5% |
0.7% | 4.9% | 8.0% | 5.9% |
1.2% | 7.2% | 6.6% | 3.3% |
3.5% | 8.6% | 15.4% | 10.4% |
-1.4% | 7.6% | 7.2% | 2.4% |
2.5% | 6.1% | 2.2% | 0.7% |
-0.7% | -2.5% | 11.7% | 13.9% |
0.4% | 1.6% | 6.8% | 6.7% |
2.6% | 3.2% | 4.9% | 4.3% |
-0.9% | 0.7% | 8.0% | 8.3% |
1.9% | 3.8% | 6.3% | 5.9% |
2.2% | 4.3% | 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 accelerated in the second quarter and substantially exceeded expectations in the first half of 2023. Nominal gross domestic product continued to slow, but after inflation, real GDP accelerated to 2.4% in Q2 (Figure 1) and 2.2% in the first half of 2023 ("H1"). That compares to economists' consensus real GDP forecast in February of just 0.8% in H1.1 Real personal consumption expenditure (PCE) slowed following a very strong Q1, but it was up a solid 2.9% in H1. Real residential investment declined at about the same pace as in Q1. Business investment rebounded strongly on higher equipment spending after an outsized decline in Q1. Real government consumption decelerated, led by a large drop in federal spending. Trade was a small positive to real GDP in Q2 while inventories were a small negative, leaving no net contribution to growth from those two sectors. Real private domestic final sales slowed a little in Q2 but were up 2.8% in H1, well ahead of its pace in 2022. The implicit deflator slowed in every sector except residential investment, where prices fell less rapidly than in Q1 (right box in Figure 1). While it does not mean inflation is slayed, a sea of green highlights inflation's broad-based improvement in Q2.
Looking ahead, economists expect GDP growth to slow from the H1 pace, but they do not forecast recession. The latest Survey of Professional Forecasters shows a median forecast for U.S. real GDP growth of 1.9% in Q3, 1.2% in Q4, and an average growth rate of 1.3% in 2024.2 While the 2024 growth forecast is only 0.3% higher than last quarter's survey, Q3 and Q4 forecasts are each roughly 1.3% higher-a major revision. Inflation forecasts are little changed, with core PCE inflation expected to fall to 2.8% in Q4 and average about 2.4% in 2024 before arriving at or near the Fed's 2.0% target in 2025.
- Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters, February 10, 2023
- Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters, August 11, 2023.
Second-Quarter U.S. Economic Update | Page 2 | August 15, 2023 |
Our economic outlook is largely unchanged from our previous Update,3 although some of the crosscurrents we discussed then are now tilting in the direction of decelerating growth and inflation. We continue to think nominal GDP growth will slow 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. Indeed, July's retail sales report suggests PCE got off to a good start in Q3. However, tight monetary policy, a resumption of federal student loan payments, and slower investment should reduce consumer and business spending and push up unemployment. Residential investment should continue to contract in the face of limited supply and high mortgage rates. Business structures spending could keep business investment growing slightly, but with borrowing costs up significantly and exports falling, business equipment spending should turn negative soon. Finally, federal government spending should slow modestly beginning in Q4. We believe the economy will slip into a mild recession starting in Q4.
Inflation is finally showing signs of broad-based improvement. Goods inflation has slowed convincingly as goods consumption cooled and supply chain bottlenecks diminished. Employment growth has slowed and unfilled jobs are down, but unemployment remains near historic lows and employment costs are still rising about 4.5%. However, services inflation has shown tentative signs of slowing recently. If we are right about moderating growth and employment, service prices should continue to slow gradually.
As a result, we believe the Fed is probably done hiking rates in this cycle, although there is still risk that one or two more hikes will be needed if inflation does not cooperate. Even if our base case forecast is correct, however, the Fed likely will leave rates at the terminal rate for an extended period, reflecting the resilience of growth and inflation. We expect rate cuts to begin around mid-2024 (slightly later than current market expectations), when we core PCE inflation should be near 3%.
Both short- and long-term interest rates have risen considerably since we last wrote in June, and they are not far from our own forecasts now. With growth risks still skewed to the upside over the next several quarters, rates may move a bit higher, but today's yields may offer an attractive entry point for long-term investors.
3 Flaherty & Crumrine First-QuarterU.S. Economic Update,June 5, 2023.
Second-Quarter U.S. Economic Update | Page 3 | August 15, 2023 |
Employment, Income and Spending
Figure 2: Employment Overview
Employment (Thousands except percents) Nonfarm Payrolls Private Household Employment Labor Participation Rate Unemployment Rate
Average Hourly Earnings
Average Hourly Earnings, All
MoMΔ (Level for Rates) | ||
Jul-23 | Jun-23May-23 | |
187 | 185 | 281 |
172 | 128 | 255 |
268 | 273 | (310) |
62.6% | 62.6% | 62.6% |
3.5% | 3.6% | 3.7% |
MoM% Change | ||
Jul-23 | Jun-23May-23 | |
0.42% | 0.45% | 0.33% |
QoQ Change | ||
2023:2 | 2023:1 | 2022:4 |
683 | 937 | 853 |
562 | 703 | 759 |
102 | 1,648 | 394 |
0.0% | 0.3% | 0.0% |
0.1% | 0.0% | 0.0% |
QoQ% Change (AR) | ||
2023:2 | 2023:1 | 2022:4 |
4.9% | 3.4% | 4.9% |
YoY% Change | Chg vs. | |
Jul-23Jun-23 | Feb-20 | |
2.2% | 2.5% | 3,971 |
2.2% | 2.4% | 4,141 |
1.8% | 1.8% | 2,513 |
0.5% | 0.4% | 0.0% |
0.0% | 0.0% | 0.0% |
YoY% Change | ||
Jul-23Jun-23 | Feb-20 | |
4.4% | 4.4% | 3.1% |
Employment Cost Index
Wages & Salaries, Civilian
QoQ% Chg (SA, not annualized) | YoY% Change (NSA) | |||||||
2023:2 | 2023:1 | 2022:4 | 2022:3 | 2023:2 | 2023:1 | 2022:4 | 2022:3 | 2019:4 |
1.0% | 1.2% | 1.2% | 1.3% | 4.6% | 5.0% | 5.1% | 5.1% | 2.9% |
The labor market cooled moderately in the second quarter (Figure 2). Nonfarm payroll growth averaged 228,000 jobs per month in Q2, down from 312,000 per month in Q1, and slipped to 187,000 in July. The unemployment rate remained low. Job openings declined and the quit rate held about steady (Figure 3). This helped slow average hourly earnings growth from 4.8% YoY in December 2022 to 4.4% YoY in July (Figure 4). Similarly, the employment cost index of wages and salaries also decelerated in Q2. However, wage inflation of around 4.5% remains too high given a 2% inflation target and only modest productivity growth of about 1.4% since the end of the global financial crisis. Job and, especially, wage growth will be key data points for policymakers at the Federal Reserve over the balance of 2023.
Figure 3: Fewer Job Openings and Quits… | Figure 4: …Driving Modest Wage Slowdown |
Figure 5: Personal Income and Spending
Second-Quarter U.S. Economic Update | Page 4 | August 15, 2023 |
Personal Income and | MoM Change | QoQ Change (AR) | YoY Change | ||||||
Consumption | Jun-23May-23Apr-23 | 2023:2 2023:1 2022:4 | 2023:2 2023:1 2022:2 | ||||||
Personal Income | 0.31% | 0.46% | 0.25% | 4.3% | 5.1% | 5.0% | 5.5% | 5.6% | 3.2% |
Wages & Salaries | 0.57% | 0.54% | 0.50% | 5.5% | 4.7% | 1.9% | 5.8% | 5.7% | 9.1% |
Real Disposable Pers. Inc. | 0.18% | 0.40% | -0.03% | 2.5% | 8.5% | 2.5% | 4.1% | 2.9% | -5.7% |
ex Transfer Payments | 0.22% | 0.36% | 0.04% | 2.2% | 0.7% | 0.0% | 1.8% | 0.9% | 0.4% |
Nominal PCE | 0.55% | 0.18% | 0.61% | 4.3% | 8.4% | 4.8% | 6.0% | 7.3% | 9.2% |
excl. Food & Energy | 0.59% | 0.37% | 0.66% | 5.0% | 10.3% | 5.3% | 7.1% | 7.9% | 8.2% |
Goods | 0.81% | -0.29% | 0.93% | 1.1% | 6.8% | -0.6% | 2.4% | 4.0% | 7.7% |
Services | 0.42% | 0.42% | 0.45% | 6.0% | 9.3% | 7.7% | 8.0% | 9.1% | 10.0% |
Real PCE | 0.39% | 0.05% | 0.27% | 1.6% | 4.2% | 1.0% | 2.3% | 2.4% | 2.4% |
Personal income slowed in both nominal and real terms in Q2 following Q1's outsized cost of living adjustments (COLA) to Social Security and other government transfer payments (Figure 5). Continued job and wage growth delivered solid gains in wage and salary income, however. Looking at year-over-year data, income growth has remained steady while spending growth has slowed (Figure 6). Although we expect nominal income growth to cool along with employment and wages, real incomes should benefit from falling inflation.
Figure 6: Spending Slowed, Income Steady | Figure 7: Consumer Confidence Rising |
Nominal personal consumption expenditure (PCE) slowed sharply in the second quarter as a Q1's COLA-induced surge in goods spending ebbed (Figure 5). Services spending also slowed but was still up 6.0% during the quarter. Adjusted for inflation, real PCE eased to 1.6% from 4.2% in Q1, for an average of 2.9% in the first half of 2023, which remains above trend. With personal income and spending growth about equal in Q2, the personal saving rate was little changed, averaging 4.4% during the quarter. We expect the saving rate to drift up over time, though, as explained below, it may dip in the closing months of the year.
So far, PCE has remained resilient. July's advance retail sales report suggests spending got off to a strong start in Q3. Consumer confidence has rebounded (Figure 7). A strong job market and higher wages have boosted wage and salary income, and investment income has
Second-Quarter U.S. Economic Update | Page 5 | August 15, 2023 |
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Flaherty & Crumrine Total Return Fund Inc. published this content on 18 August 2023 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 18 August 2023 20:02:04 UTC.
