FLAHERTY & CRUMRINE DYNAMIC PREFERRED AND INCOME FUND INC. Third-Quarter U.S. Economic Update
November 2022
Summary of Recent Economic and Market Developments
The U.S. economy resumed growth in the third quarter of 2022 after contracting slightly in the first half, but the composition of growth deteriorated. Overall real GDP rose 2.6% in Q3 on the back of a 2.8% contribution from net exports. Hiring remained sturdy, and wage growth slowed marginally. Wage and salary income posted another strong gain, pushing disposable personal income up 1.7% after inflation. Real personal consumption expenditures rose 1.4%, down slightly from Q2 as consumers continued to shift spending toward services. Home sales slowed sharply, and real residential investment plunged by more than 26% on a combination of high home prices and rapidly rising mortgage rates. Industrial output rose by 2.9%, less than in recent quarters, and manufacturing surveys suggest lower output ahead. Real business investment rose moderately (3.7%). Other sectors-trade (+2.8%), inventories (-0.7%), and government consumption (+0.4%)-together contributed 2.5% to real GDP. That left core GDP growth, real private domestic final sales, up only 0.1%.
Lower energy prices pushed down inflation as measured by the GDP implicit deflator in nearly all sectors, but the consumer price index and PCE deflator were down only slightly. Year-over-year CPI rose 8.3% in Q3, and the PCE deflator rose 6.3% YoY in Q3; both were just 0.3% lower than in Q2. Core inflation (excluding volatile food and energy prices) was mixed. Core CPI rose 6.3% YoY in Q3, up from 6.0% in the prior quarter. The core PCE deflator rose 4.9% YoY in Q3, just 0.1% better than in Q2. However, October's CPI and producer price index (PPI) reports showed larger improvements. We expect inflation in goods prices to fall quickly over the next six months. Services inflation should also slow, but stubbornly high wage costs could postpone rapid declines until the second half of 2023.
The Federal Reserve continued to hike the fed funds rate in 75 bp increments in July, September, and November, pushing the fed funds target range up to 3.75-4.00% currently. Market forward rates show the fed funds rate peaking at about 5% in 2Q2023, falling about 50 bp in the second half of 2023, and more rapidly in 2024. Yields on intermediate-term Treasuries rose sharply in Q3 and through early November, but better inflation news sparked a rally that has left rates about 50 bp below their recent peak. Credit spreads continued to mirror macroeconomic news and followed a similar pattern: wider overall but with substantial narrowing in the past few weeks.
Although we anticipate a mild recession in the second half of 2023, fundamental credit quality remains healthy. 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.
Third-Quarter U.S. Economic Update | Page 1 | November 23, 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 | 2022:3 | 2022:2 | 2021* | 2020* | 2022:3 | 2022:2 | 2021* | 2020* | 2022:3 | 2022:2 | 2021* | 2020* |
Gross Domestic Product (GDP) | 2.6% | -0.6% | 5.7% | -1.5% | 6.7% | 8.5% | 12.2% | 0.0% | 4.1% | 9.1% | 6.1% | 1.5% |
Personal Consumption Expenditures | 1.4% | 2.0% | 7.2% | -1.4% | 5.7% | 9.5% | 13.2% | -0.2% | 4.2% | 7.3% | 5.7% | 1.1% |
PCE: Goods | -1.2% | -2.6% | 7.1% | 8.6% | 1.5% | 7.8% | 15.6% | 8.0% | 2.8% | 10.6% | 7.9% | -0.5% |
PCE: Services | 2.8% | 4.6% | 7.2% | -5.8% | 7.9% | 10.4% | 12.0% | -4.0% | 4.9% | 5.6% | 4.5% | 2.0% |
Fixed Investment | -4.9% | -5.0% | 3.7% | 1.0% | 2.3% | 4.7% | 9.8% | 3.0% | 7.6% | 10.3% | 5.9% | 2.0% |
Business Investment | 3.7% | 0.1% | 5.0% | -3.5% | 11.4% | 8.6% | 8.5% | -2.4% | 7.4% | 8.5% | 3.3% | 1.1% |
Structures | -15.3% | -12.7% | -5.2% | -16.0% | 1.5% | 2.5% | 4.7% | -16.1% | 19.9% | 17.5% | 10.4% | -0.1% |
Equipment | 10.8% | -2.0% | 4.7% | -2.7% | 17.1% | 7.0% | 7.2% | -3.3% | 5.7% | 9.2% | 2.4% | -0.7% |
Intellectual Property | 6.9% | 8.9% | 10.8% | 3.8% | 10.8% | 13.2% | 11.6% | 7.7% | 3.6% | 3.9% | 0.7% | 3.7% |
Residential Investment | -26.4% | -17.8% | -0.3% | 16.4% | -20.3% | -5.3% | 13.6% | 22.0% | 8.3% | 15.2% | 13.9% | 4.8% |
Government Consumption | 2.4% | -1.6% | 0.5% | 1.0% | 5.7% | 9.7% | 7.3% | 3.6% | 3.2% | 11.6% | 6.7% | 2.5% |
Federal | 3.7% | -3.4% | 0.4% | 5.4% | 8.7% | 2.4% | 4.6% | 7.2% | 4.8% | 6.0% | 4.3% | 1.7% |
State & Local | 1.7% | -0.6% | 0.6% | -1.6% | 4.0% | 14.3% | 9.0% | 1.4% | 2.2% | 15.0% | 8.3% | 3.0% |
Domestic Final Sales | 0.5% | 0.2% | 5.4% | -0.6% | 5.1% | 8.7% | 11.6% | 1.0% | 4.6% | 8.5% | 5.9% | 1.5% |
Private Domestic Final Sales | 0.1% | 0.5% | 6.4% | -0.9% | 5.0% | 8.5% | 12.5% | 0.4% | 4.9% | 7.9% | 5.7% | 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. Green (red) shading denotes improving (worsening) values.
U.S. economic growth rebounded in the third quarter as the trade deficit narrowed sharply. Gross domestic product after inflation (real GDP) rose by 2.6% on a combination of slightly weaker nominal growth and lower inflation (Figure 1). However, the composition of growth deteriorated. Net exports added 2.7% to real GDP (and likely will not be repeated), but real domestic final sales rose just 0.5% and private domestic final sales were nearly flat. Residential investment was extremely weak, down more than 20% in both nominal and real terms. Business investment fared better, although investment in structures remained weak. Real personal consumption expenditure grew modestly as consumers shifted spending toward services. Consumer goods spending slipped for the third consecutive quarter. Real government consumption rose for the first time in a year. Although inflation remains too high, the implicit deflator slowed in almost all major sectors of the economy in Q3.
Economists forecast U.S. real GDP will expand by 0.5% in Q4 and 1.8% in 2022.1 They expect growth of 0.5% in 2023, as monetary tightening weighs on the economy, and 1.4% in 2024, as that begins to unwind. The core PCE deflator is forecast to rise 4.8% YoY in Q4 (near its Q3 pace), 3.0% YoY in 4Q2023, and average 2.4% in 2024.
With higher interest rates beginning to bite, we think nominal GDP growth will slow over coming quarters as consumers deplete savings from the pandemic and continue to reduce spending, but falling inflation should keep real GDP growth positive in the first half of 2023. Residential investment is likely to remain weak (although probably not as bad as in Q3), and business investment should slow as businesses turn more cautious. As we expected, services inflation remains sticky, but goods inflation is slowing rapidly. As the economy slows and unemployment rises, wage growth should moderate and drive down services inflation. That process may take time, however. As a result, the Fed is set to further tighten monetary policy over the coming meetings and perhaps leave rates at a restrictive level for longer than
- Bloomberg Monthly Economic Survey, November 15, 2022, Bloomberg L.P.
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markets currently expect. While there is a narrow path to lower inflation and continued economic growth through 2024, we think a recession beginning in the second half of 2023 is more likely. However, we still do not see excessive investment in homes, inventories, or business plant and equipment that typically leads from boom to bust-a recession should be mild.
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Employment, Income and Spending
Figure 2: Employment Overview
Employment | MoMΔ (Level for Rates) | QoQ Change | YoY% Change | Chg vs. | |||||
(Thousands except percents) | Oct-22Sep-22Aug-22 | 2022:3 | 2022:2 | 2022:1 | Oct-22Sep-22 | Feb-20 | |||
Nonfarm Payrolls | 261 | 315 | 292 | 1,144 | 1,047 | 1,616 | 3.6% | 3.9% | 804 |
Private | 233 | 319 | 233 | 1,000 | 1,045 | 1,581 | 4.0% | 4.4% | 1,333 |
Household Employment | (328) | 204 | 442 | 825 | (347) | 2,483 | 2.7% | 3.2% | (258) |
Labor Participation Rate % | 62.2% | 62.3% | 62.4% | 0.1% | -0.2% | 0.5% | 0.5% | 0.6% | -1.2% |
Unemployment Rate | 3.7% | 3.5% | 3.7% | -0.1% | 0.0% | -0.3% | -0.9% | -1.2% | 0.2% |
MoM% Change | QoQ% Change, AR | YoY% Change | |||||||
Average Hourly Earnings | Oct-22Sep-22Aug-22 | 2022:3 | 2022:2 | 2022:1 | Oct-22Sep-22 | Feb-20 | |||
Average Hourly Earnings, All | 0.37% | 0.31% | 0.28% | 4.4% | 4.6% | 4.8% | 5.4% | 4.9% | 3.7% |
QoQ% Chg (not annualized) | YoY% Change | ||||||||
Employment Cost Index | 2022:3 | 2022:2 | 2022:1 | 2021:4 | 2022:3 | 2022:2 | 2022:1 | 2021:4 | 2019:4 |
Employment Cost, Total, Civilian | 1.2% | 1.3% | 1.4% | 1.0% | 5.0% | 5.1% | 4.5% | 4.0% | 2.7% |
The labor market is showing some signs of cooling, but it remained very tight in the third quarter. Nonfarm payroll growth accelerated slightly in Q3, although it slowed a bit in October (Figure 2). That is still significantly faster than underlying growth in the labor force. The unemployment rate rose to 3.7% in October only because the household survey recorded 328,000 job losses, much worse than the nonfarm survey. The gap between the household employment and nonfarm payroll surveys has widened again, with the former showing fewer jobs than in February 2020 and the latter showing more (Figure 2, last column). Currently, we think the much larger payroll survey better reflects the state of the labor market, but the sustained weakness in the household survey could signal a downturn and bears watching.
Figure 3: Wages Slowing, but Labor Tight | Figure 4: Wages Driving Spending; Savings Slip |
U.S. Wage Growth and Unemployment Rate | |||||||
15 | 9 | ||||||
14 | 8 | ||||||
13 | YoY | ||||||
12 | 7 | ||||||
Percent | 11 | 6 | orWage | ||||
Rate,Unemployment | 10 | 5.1 | PercentGrowth,Earnings | ||||
9 | 4.7 | ||||||
8 | 4 | ||||||
7 | 3 | ||||||
6 | |||||||
2 | |||||||
5 | |||||||
4 | 1 | ||||||
3.7 | |||||||
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
Nominal Personal Income, Consumption and Savings, YoY | |||||||||||||
35 | 35 | ||||||||||||
30 | |||||||||||||
30 | 25 | ||||||||||||
PercentGrowth,Spending& Income | |||||||||||||
25 | 20 | ||||||||||||
PercentRate,Savings | |||||||||||||
15 | |||||||||||||
20 | 8.2 | ||||||||||||
8.2 | |||||||||||||
15 | 5.2 | ||||||||||||
0 | |||||||||||||
10 | -5 | ||||||||||||
-10 | |||||||||||||
5 | |||||||||||||
3.1 | |||||||||||||
0 | -20 | ||||||||||||
Jan | Apr | Jul | Oct | Jan | Apr | Jul | Oct | Jan | Apr | Jul | Oct | ||
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
Although employment growth remains sturdy, it has slowed from almost 540,000 jobs per month in the first quarter to about half that pace (261,000 new hires) in October. Job openings
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have slowed as well. The 3-month moving average of job openings was 10.7 million in September (latest data available), down significantly from its April peak of 11.6 million. However, that still leaves the latest ratio of job openings to unemployed persons at 1.86, compared to about 1.2 prior to the pandemic. Tighter monetary policy and a slower pace of hiring is dampening wage growth, but weak labor participation has kept the labor market tight (Figure 3). The Fed needs to bring wage growth down to around 3% to be consistent with its 2% inflation target. That is likely to require a sustained period of restrictive monetary policy and at least moderately higher unemployment. We expect employment growth to slow further over coming months.
Figure 5: Personal Income and Spending
Personal Income and | MoM Change | QoQ Change (AR) | YoY Change | ||||||
Consumption | Sep-22Aug-22Jul-22 | 2022:3 2022:2 2022:1 | 2022:3 2022:2 2021:3 | ||||||
Personal Income | 0.36% | 0.38% | 0.39% | 5.5% | 5.9% | 3.0% | 4.3% | 3.4% | 4.9% |
Wages & Salaries | 0.56% | 0.33% | 0.82% | 7.3% | 6.9% | 6.8% | 8.5% | 9.6% | 10.6% |
Real Disposable Pers. Inc. | 0.05% | 0.19% | 0.54% | 1.7% | -1.5% | -10.6% | -3.9%-5.5%-1.5% | ||
ex Transfer Payments | 0.13% | 0.18% | 0.69% | 2.5% | -0.4% | -2.2% | 0.6% | 0.6% | 3.2% |
Nominal PCE | 0.65% | 0.56% | -0.23% | 5.7% | 9.5% | 8.9% | 8.4% | 9.2% | 12.2% |
excl. Food & Energy | 0.72% | 0.83% | 0.11% | 6.9% | 8.2% | 7.8% | 7.9% | 8.2% | 11.9% |
Goods | 0.31% | -0.37% | -0.80% | 1.5% | 7.8% | 12.5% | 8.3% | 7.7% | 12.7% |
Services | 0.82% | 1.05% | 0.08% | 7.9% | 10.4% | 7.1% | 8.4% | 10.0% | 12.0% |
Real PCE | 0.31% | 0.29% | -0.11% | 1.4% | 2.0% | 1.3% | 2.0% | 2.4% | 7.4% |
Personal income expanded a bit more slowly in nominal terms in the third quarter, but lower inflation pushed real disposable personal income growth back into positive territory (Figure 5). Rising hourly pay and employment produced a solid 7.3% gain in wage and salary income (Figures 4 and 5, respectively). Looking ahead, we expect nominal personal income growth to slow but be accompanied by a decline in inflation that should accelerate over the next several quarters (see page 13 for our thoughts on inflation). Real disposable personal income should grow by 1.0-1.5% in the first half of 2023 but stall in the second half as tighter monetary policy cools the labor market and recession takes hold.
Nominal personal consumption expenditure (PCE) slowed in the third quarter (Figure 4). Goods spending slowed sharply, while services expenditure remained high (Figure 5). After inflation, real PCE growth was up 1.4% in Q3, down slightly from the prior quarter. Although the labor market has cooled a bit, U.S. consumers continue to see higher wages and good job availability, which has boosted wage and salary income and-along with savings-sustained spending. We expect resilient nominal spending and lower inflation to keep real PCE growth near its current level through the first quarter of 2023 before turning negative in the second half as economic headwinds build. Consumer confidence is already weak (Figure 6). The University of Michigan's consumer sentiment survey reports overall confidence at a level typical during a recession. The Conference Board survey does not look as bad, but it too is down sharply. Moreover, the index of leading economic indicators (LEI) suggests a recession is looming. Figure 7 shows the LEI expressed as a 6-month annualized rate of change, lagged by six months. Since the inception of the index in 1959, whenever the 6-month annual rate
Third-Quarter U.S. Economic Update | Page 5 | November 23, 2022 |
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Flaherty & Crumrine Dynamic Preferred and Income Fund Inc. published this content on 29 November 2022 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 30 November 2022 03:02:02 UTC.
