The outlook worsened further over the last month.
The University of Michigan’s Consumer Sentiment Indicator and expectations of small business owners in the National Federation of Independent Business’s monthly survey have both fallen to record lows — and a survey of community bank CEOs conducted by the American Bankers Association shows more than nine in 10 expect a recession over the next 1-2 years.
CPI inflation jumped more than expected to a new 40-year high in June as national gas prices soared above $5 per gallon, and the yield curve—the differential between the yields on two-year Treasury notes and ten-year notes—turned negative, a sign that financial markets, like consumers, small business owners, and community bankers, see rising risk of a recession ahead.
All is not lost. Wealthier consumers are still catching up on spending on travel, dining out, and entertainment that they skipped in 2020 and 2021, which is fueling continued growth of the service sector, which employs four in five private workers. While pockets of the economy are starting to see job losses, including big box retail, tech, mortgage finance, and parts of manufacturing, labor demand remains extremely high, and laid-off workers are finding new jobs much faster than in a conventional downturn.
Strong labor demand is also helping lower- and middle-income households supplement incomes by taking on additional shifts or jobs. After a surge to record highs in June, gasoline prices are coming back down, and futures prices of other energy, metals, and food commodities fell over the second quarter as well. That should help slow inflation in the second half of 2022.
Even so, downside risk to the economy continues to rise. With growth momentum weakening, one more negative shock would be enough to push the U.S. into a recession. And risks of such a shock from abroad are high. The Russia-Ukraine war could cause a European energy crisis in the winter heating season; China’s lockdowns and housing market correction could weaken foreign economies even more.
Comerica’s July outlook assumes these foreign shocks do not become big enough to tip the U.S. into a recession, but that risk—rather than the muddle-through described by our forecast—is roughly a coin toss.
Following June’s worse-than-expected CPI inflation of 9.1% and better-than-expected payroll job growth of 372,000, the Fed will make another big interest rate hike at its July 27 interest rate decision. At their last decision, Chair Powell said the July meeting would probably be a choice between a half percentage point hike and a three quarters of a percent hike.
But data out since Chair Powell spoke make the July decision more likely to be between a three quarters of a percent hike, which is Comerica’s forecast, or a hike of a full percentage point. Comerica forecasts another percentage point of federal funds rate hikes by year-end 2022, and unchanged rates in 2023. Financial markets are pricing in the possibility of interest rate cuts next year, another sign of recession fears.
Bill Adams is senior vice president and chief economist at Comerica.