MANHATTAN (CN) — Investors rallied late in the week, capping a fourth consecutive week of gains, erasing much of the summer’s losses and nearly reaching the highs from May.
The gains are likely due to a pair of positive economic releases on inflation and growth that suggest the United States was never in a recession earlier this year and that prices are likely to come down soon.
Investors were cheered on Friday by data from showing that personal income and expenditures both outpaced inflation in September, gaining 0.4% and 0.6%, respectively, which lends credence to the belief that inflation has peaked.
This marks the second consecutive month that real consumer spending has increased — though the savings rate fell from August — with analysts guessing consumers are tapping into savings and credit to buy their goods and services. While the price of goods still outpace income from a year ago, prices have fallen for the third month in a row.
On the heels of the reports, markets continued their move in a positive direction, the Dow Jones Industrial Average met the closing bell 1,779 points up since last Friday, and the S&P 500 gained 149 points over that same time frame. The Nasdaq, which has been plagued by earnings woes among its tech-heavy listings, gained 243 points since last Friday.
The PCE release wasn’t the only one that helped motivate the bulls this week. On Thursday, the U.S. Bureau of Economic Analysis reported that gross domestic product gained 0.6% in the third quarter for 2.6% annualized, reversing the negative trend from the prior two quarters and dissipating talk of a recession. The better-than-expected gains were driven mostly by a resilient consumer sector, experts say, as did the narrowing trade deficit.
Because a notable drop in residential investment has held back growth, however, the numbers could have been better. Compared with a 17% drop in the second quarter of 2022 and a 3% decline in the first, residential investment fell by more than 26% last quarter. The slowdown in the housing sector shows no signs of slowing, as interest rates and home prices both remain high.
“Real GDP increased in the third quarter, but I don’t expect this growth to continue later this year or early next,” John Leer, chief economist at Morning Consult, said in a statement, noting that weak global demand and a strong U.S. dollar will limit export growth going forward and that the drop in household savings will cause consumers to pare spending in the months ahead.
The GDP Price Index also slowed from the second quarter — it gained 4.6% in the third quarter compared with 8.5% in the second — which was well below expectations. That indicates both that growth will not return to the levels seen earlier this year and last and that the hottest inflation is in the rear-view window.
“A mild recession is looming with relatively high interest rates and persistent cost pressures set to spark the downturn,” Oren Klachkin at Oxford Economics wrote. “Inflation may be reaching a turning point but it’s unlikely to normalize quickly, and interest rates will remain higher than during the last economic expansion.”
Klachkin predicts weaker GDP growth during the fourth quarter of this year, followed by two consecutive negative quarters to kick off 2023. “Last quarter’s GDP growth advance is unlikely to persist, as challenges from high inflation and aggressive Fed tightening weigh on the economy.”
The recent PCE data — which is one of the leading indicators the Fed uses to measure inflation — and Thursday’s GDP release are likely to have only minimal impact on next week’s decision by the central bank, though analysts say both reports portend good things for December and possible “Fed pivot” in early 2023.
“The Fed will almost certainly raise its policy rate three quarters of a percent at their decision next week,” Bill Adams, chief economist at Comerica Bank, said after Friday’s PCE release. “But with evidence growing that inflation is past the peak, November’s hike will probably be the last one that big in this cycle.”
Since the beginning of the year, the Fed has raised the federal funds interest rates by 3%, most notably in a trio of 0.75% interest-rate hikes in June, July and September. The central bank has two more meetings for the year, during which experts have forecast a combined 1.25% increase in interest rates.
With regard to 2023, Adams is no Pollyanna, noting that the drop in the housing market and overall slowing economy will cause inflation to continue to cool into next year. “The most likely outcome is a weaker U.S. and global economy allow the Fed to begin reducing interest rates in the second half of 2023,” he said. “But inflation persisting longer than expected, forcing the Fed to keep short-term interest rates higher, would not be a surprise.”
He also warned that a dramatic fall in housing activity domestically and recessions in foreign economies could damper U.S. growth and bring down inflation faster than expected. Inflation remains one of the most persistent problems for the U.S. economy and a major issue leading into the 2022 midterm elections.
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