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Talk Shifts From Inflation to Prospects for Recession

Yet Second-Quarter GDP Forecasts Remain Positive, for Now

Both pending home sales in May and mortgage applications for the week ending on June 17 moved higher, demonstrating some lasting resilience of the housing market as buyers evidently rush to beat even higher mortgage rates that are sure to arrive. But downbeat news came from the University of Michigan’s Consumer Sentiment Index, which showed that consumers are becoming increasingly worried, with the index falling to its lowest level in its 45-year history. And the four-week trailing average of jobless claims edged slightly higher last week, according to the Department of Labor.

In all, the week was light in new economic data releases. But that gives us a chance to focus more on how some forecasts see the economy evolving over the next few quarters.

Projections for second-quarter real gross domestic product remain out of the red even as the Federal Reserve has tightened monetary policy and warns of a possible recession. In a June 10 update, Oxford Economics raised its second-quarter forecast to 3% from a May 12 projection of 1.8%, attributing the gain to strong consumer spending amid continued healthy job gains, as spending pivots away from goods and toward services, such as travel and entertainment. Oxford Economics suggests that the Federal Reserve will be able to navigate a soft landing as supply chain disruptions ease and more people return to work, alleviating some of the pricing pressures that have arisen over the pandemic. However, it notes that tightening monetary policy could lead to slower growth for several years, with GDP growth moderating to a 2% rate in the second half of 2022 and 1.8% in 2023.

The Atlanta Federal Reserve’s GDPNow model is well known for providing frequent updates following data releases that are used as inputs to its model. On June 27, the model projected GDP growth of 0.3% for the second quarter of 2022, up from its June 16 forecast for zero growth. The new data boosting the rate came from the manufacturing sector as new durable goods orders excluding non-defense items grew by 0.7% in May over the month, and 9.8% over the year. While new orders are measured in nominal terms, the increase suggests some relief in goods that are in short supply, helping to ease inflation. Still, the model is projecting ultra-slow growth following the contraction experienced in the first quarter of the year.

Recent changes to the Federal Reserve’s policy stance make traditional forecasting difficult. After all, the Fed is undertaking an aggressive challenge to battle inflation. The federal funds rate has been historically low for years, and accommodative policies drove the Fed’s balance sheet up to reach almost $9 trillion at the end of 2021, more than twice its pre-pandemic size. The speed with which the Fed appears now ready to raise rates and unwind its assets is jarring. The New York Federal Reserve’s DSGE (dynamic stochastic general equilibrium) forecast model might be well suited to examine the consequences of these moves because, among other things, it has been specifically designed to account for forward guidance in monetary policy. However, the model’s current projections are rather pessimistic. In its June 17 update, the mean forecast for fourth-quarter year-over-year GDP growth for 2022 was a negative 0.6%, a reversal from its March update that called for positive 0.9% growth over the same period. While the model has a wide error band around its projections, the mean forecast suggests that a recession could be prolonged, with GDP contracting by 0.5% in 2023 and growing by just 0.4% in 2024.

What We’re Watching …

Of particular attention to most forecasters is the health of the consumer, whose spending props up the economy and is hoped to be robust enough to prevent the economy from falling into a recession. The Commerce Department’s report on personal incomes and outlays, to arrive this Thursday, should provide some insight on where things stood in May. Consumers have not been shy to spend over the pandemic, with savings accounts padded with the proceeds of several stimulus programs, but inflation is eating away at their purchasing power

now, and souring sentiment can play a large role in curtailing future spending plans.

Posted with Permission: CoStar Economy is produced weekly by Christine Cooper, managing director and chief U.S. economist, and Rafael De Anda, associate director of CoStar Market Analytics in Los Angeles.

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