Summary
AIER’s Leading Indicators Index held at 25 in October. The latest result is the fifth consecutive month below the neutral 50 threshold. The low readings are consistent with weakness in the economy and significantly elevated risks for the outlook.
The first estimate of third-quarter real gross domestic product (GDP) came in at a 2.6 percent annualized growth rate, following rates of -1.6 percent in the first quarter and -0.6 percent for the second quarter. Real final sales to private domestic purchasers, about 88 percent of real GDP and arguably a better measure of private domestic demand, has shown greater resilience, with growth having stayed positive despite declines in real GDP. However, domestic demand growth has slowed significantly, from a 2.6 percent pace in the fourth quarter of 2021 to 2.1 percent in the first quarter, 0.5 percent in the second quarter, and just 0.1 percent in the third quarter.
Consumers remain the cornerstone of the U.S. economy with real consumer spending accounting for about 70 percent of real GDP and about 80 percent of real domestic demand. For consumers, the labor market remains tight with payrolls continuing to expand (though the pace appears to be slowing), job openings at a high level, and layoffs hovering near lows. The solid labor market supports positive consumer attitudes but that is offset but high inflation and rapid interest rate increases that threaten future economic growth.
The longer elevated rates of price increases continue and the higher the Fed raises interest rates, the higher the probability that a vicious cycle of declining economic activity and contracting labor demand will begin to dominate the economy. Overall, the outlook remains highly uncertain. Caution is warranted.
AIER Leading Indicators Index Holds at 25 in October, Signaling Significant Risks
In the October update, the AIER Leading Indicators index remained at 25. The October result is down 67 points from the March 2021 high of 92. Excluding the lockdown recession of 2020, it matches the lowest level since the recovery from the 2008-2009 recession. With the latest reading holding well below the neutral 50 threshold, the AIER Leading Indicators Index is signaling economic weakness and significantly elevated outlook risks.
Two leading indicators had offsetting signal changes in October. The real retail sales indicator weakened from a neutral trend to a negative trend. This indicator has been volatile recently, changing signals six times in the last twelve months. Indicators often become volatile around inflection points.
The second indicator to change trend in October was the real new orders for consumer goods indicator. It reversed its September weakening, improving from a neutral to a positive trend and offsetting the deterioration in the real retail sales indicator. This indicator has also been volatile recently, changing trend in each of the last three months. Given the erratic performance of real core retail sales and rising real manufacturing and trade inventories (an AIER lagging indicator), it’s not surprising to see new orders become volatile.
Among the 12 leading indicators, three were in a positive trend in October, nine were trending lower, and none were trending flat or neutral.
The Roughly Coincident Indicators index improved in October, coming in at 75 following three consecutive months at 67. Before the three-month run at 67, the indicator posted a 75 in June, 83 in May, and a perfect 100 in April. The Roughly Coincident Indicators Index has been above the neutral 50 threshold since September 2020.
Three indicators changed signal last month. Real manufacturing and trade sales improved from a negative trend to a neutral trend. This indicator had been in a negative trend for five consecutive months. The real personal income excluding transfers indicator improved to a positive trend from a neutral trend in September. The Conference Board Consumer Confidence in the Present Situation indicator weakened to a negative trend from a neutral trend in the prior month.
In total, four roughly coincident indicators – nonfarm payrolls, employment-to-population ratio, real personal income excluding transfers, and industrial production – were trending higher in October while the real manufacturing and trade sales indicator was in a neutral trend, and the Conference Board Consumer Confidence in the Present Situation indicator was in a negative trend. Given the poor performance of the AIER Leading Indicators Index, it would not be surprising to see declines in the Roughly Coincident Index in the coming months.
AIER’s Lagging Indicators index rose to 83 in October after 67 in September and 83 for seven consecutive months from February through August. Two indicators changed trend for the month. The composite short-term interest rates indicator and the 12-month change in the core Consumer Price Index indicator improved from neutral to favorable trends. In total, five indicators – the duration of unemployment indicator, the real manufacturing and trade inventories indicator, the composite short-term interest rates indicator, the 12-month change in the core Consumer Price Index indicator, and the commercial and industrial loans indicator – were in favorable trends, and one indicator, real private nonresidential construction, had an unfavorable trend.
Overall, the AIER Leading Indicators Index remained well below neutral in the latest month, signaling broadening economic weakness and sharply elevated levels of risk for the outlook. The economy is facing significant headwinds from elevated rates of price increases and an aggressive Fed tightening cycle. Particularly important for the outlook is the strength of the labor market. A deeper and sharper economic contraction becomes more probable if significant declines in payrolls begin to occur. Fed policy is likely to be a key factor in the progression of the labor market. Furthermore, the fallout from the Russian invasion of Ukraine and periodic lockdowns in China continue to boost uncertainty. Caution is warranted.
Solid Third Quarter GDP Number Masks Pockets of Weakness
Real gross domestic product rose at a 2.6 percent annualized rate in the third quarter versus a 0.6 percent rate of decline in the second quarter and -1.6 pace in the first quarter. Over the past four quarters, real gross domestic product is up 1.8 percent.
Real final sales to private domestic purchasers, about 88 percent of real GDP and a key measure of private domestic demand, has shown greater resilience, with growth having stayed positive despite declines in real GDP. However, growth has slowed significantly, from a 2.6 percent pace in the fourth quarter of 2021 to 2.1 percent in the first quarter, 0.5 percent in the second quarter, and just 0.1 percent in the third quarter. Over the last four quarters, real final sales to private domestic purchasers are up 1.3 percent.
Real GDP and real final sales to private domestic purchasers are close to their 10-year trends. The data shown in the current report are based on incomplete information and will likely be revised in subsequent releases.
Headline numbers like GDP don’t provide a complete picture. Despite a solid result for real GDP growth in the third quarter, performance among the various components of GDP were mixed. Among the components, real consumer spending overall rose at a 1.4 percent annualized rate and contributed a total of 0.97 percentage points to real GDP growth. Over the last 40 years, consumer spending has posted average annualized growth of about 3.0 percent and contributed an average of 2.0 percentage points to real GDP growth.
Consumer services led the growth in overall consumer spending in the third quarter, posting a 2.8 percent annualized rate, adding 1.24 percentage points to total growth. Durable-goods spending fell at a 0.8 percent pace, the second consecutive decline, subtracting 0.07 percentage points while nondurable-goods spending fell at a -1.4 percent pace, the third consecutive drop, subtracting 0.20 percentage points.
Business fixed investment increased at a 3.7 percent annualized rate in the third quarter of 2022, adding 0.49 percentage points to final growth. Intellectual-property investment rose at a 6.9 percent pace, adding 0.36 points to growth while business equipment investment rose at a 10.8 percent pace, adding 0.54 percentage points. However, spending on business structures fell at a 15.3 percent rate, the sixth decline in a row, subtracting 0.41 percentage points from final growth.
Residential investment, or housing, plunged at a 26.4 percent annual rate in the third quarter, following a 17.8 annualized fall in the prior quarter. The drop in the third quarter was the sixth consecutive decline and subtracted 1.37 percentage points from third quarter growth.
Businesses added to inventory at a $61.9 billion annual rate (in real terms) in the third quarter versus accumulation at a $110.2 billion rate in the second quarter. The slower accumulation reduced third-quarter growth by 0.70 percentage points. That followed a sizable 1.91 deduction from second quarter real GDP growth that more than accounted for the 0.6 percent decline in the headline result. Swings in inventory accumulation often add significant volatility to headline real GDP.
Exports rose at a 14.4 percent pace while imports fell at a 6.9 percent rate. Since imports count as a negative in the calculation of gross domestic product, a drop in imports is a positive for GDP growth, adding 1.14 percentage points in the third quarter. The rise in exports added 1.63 percentage points. Net trade, as used in the calculation of gross domestic product, contributed 2.77 percentage points to overall growth, helping to hide the weakness in domestic demand.
Government spending rose at a 2.4 percent annualized rate in the third quarter compared to a 1.6 percent pace of decline in the second quarter, adding 0.42 percentage points to growth.
Consumer price measures showed another rise in the third quarter, though the pace decelerated. The personal-consumption price index rose at a 4.2 percent annualized rate, below the 7.3 percent pace in the second quarter and the 7.5 percent rate in the first quarter. From a year ago, the index is up 6.3 percent. However, excluding the volatile food and energy categories, the core PCE (personal consumption expenditures) index rose at a 4.5 percent pace versus a 4.7 percent increase in the second quarter and 5.6 percent in the first quarter. That is the slowest pace of rise since the first quarter of 2021. From a year ago, the core PCE index is up 4.9 percent.
Payroll Growth Continues, but the Pace Is Slowing
Total nonfarm payrolls posted a 261,000 gain in October versus a 315,000 rise in September (revised up by 52,000), while August had an increase of 292,000 (revised down by 23,000). Over the last three months, the average gain is 289,300 versus a 12-month average of 441,900.
Excluding the government sector, private payrolls posted a gain of 233,000 in October following the addition of a net 319,000 jobs in September. The average monthly gain over the 22 months since January 2021 was 461,000. However, the monthly increases appear to be slowing. Over the 14 months from January 2021 through February 2022, the average monthly rise was 535,000; for the five months from March 2022 through July 2022, the average was 376,000; and over the last three months, the average has dropped to 262,000.
Though the net gains are decelerating, the gains in October were widespread. Within the 233,000 increase in private payrolls, private services added 200,000 versus a 12-month average of 355,800 while goods-producing industries added 33,000 versus a 12-month average of 64,800.
Within private service-producing industries, education and health services increased by 79,000 (versus a 77,300 twelve-month average), business and professional services added 39,000 (versus 72,800), leisure and hospitality added 35,000 (versus 96,500), and wholesale trade gained 14,600 (versus 17,200).
Within the 33,000 addition in goods-producing industries, durable-goods manufacturing rose by 23,000, nondurable-goods manufacturing expanded by 9,000, construction added 1,000, and mining and logging industries was unchanged.
While a few of the services industries dominate actual monthly private payroll gains, monthly percent changes paint a different picture. Gains were more evenly distributed, as ten industries gained more than 0.1 percent, and six of those posted a gain of more than 0.2 percent.
Average hourly earnings for all private workers rose 0.4 percent in October, above the 0.3 percent September gain. That puts the 12-month gain at 4.7 percent, down from a recent peak of 5.6 percent in March. Average hourly earnings for private, production and nonsupervisory workers rose 0.3 percent for the month and are up 5.5 percent from a year ago, down from 6.7 percent in March.
The average workweek for all workers held for the fifth consecutive month at 34.5 hours in October while the average workweek for production and nonsupervisory remained at 34.0 hours.
Combining payrolls with hourly earnings and hours worked, the index of aggregate weekly payrolls for all workers gained 0.6 percent in October and is up 8.0 percent from a year ago; the index for production and nonsupervisory workers rose 0.4 percent and is 8.9 percent above the year ago level.
The total number of officially unemployed was 6.059 million in October, a rise of 306,000. The unemployment rate rose 0.2 percentage points to 3.7 percent, reversing the 0.2 percentage point drop in September, while the underemployed rate, referred to as the U-6 rate, decreased by 0.1 percentage points to 6.8 percent in October. Both measures have been bouncing around in a flat trend over the last few months.
The employment-to-population ratio, one of AIER’s Roughly Coincident indicators, came in at 60.0 percent for October, down 0.1 from September and still significantly below the 61.2 percent in February 2020.
The labor force participation rate fell by 0.1 percentage point in October to 62.2 percent. This important measure has been trending flat recently, matching the 62.2 percent reading in January 2022. Labor force participation is still well below the 63.4 percent of February 2020.
The total labor force came in at 164.667 million, down 22,000 from the prior month and nearly matching the February 2020 level. If the 63.4 percent participation rate were applied to the current working-age population of 264.535 million, an additional 3.04 million workers would be available.
The October jobs report shows total nonfarm and private payrolls posted additional albeit slower gains than recent prior periods. Continued gains in employment are a positive sign, providing support to consumer attitudes and consumer spending. However, concerns about future payroll gains continue in light of aggressive Fed interest rate increases. Still, the level of open jobs remains high and initial claims for unemployment insurance remain low, suggesting the labor market remains tight.
Weekly Initial Claims Suggest the Labor Market Remains Tight
Initial claims for regular state unemployment insurance fell by 1,000 for the week ending October 29th, coming in at 217,000. The previous week’s 218,000 was revised up from the initial estimate of 217,000. Claims have fallen in eight of the last 12 weeks, but the changes over the last five weeks have been small. When measured as a percentage of nonfarm payrolls, claims came in at 0.136 percent for September, down from 0.160 in August but above the record low of 0.117 in March. Overall, the level of weekly initial claims for unemployment insurance remains very low by historical comparison.
The four-week average fell to 218,750, down 500 from the prior week. The four-week average peaked in early August and trended lower through the end of September but has risen slightly since the low. Overall, the data continue to suggest a tight labor market.
The number of ongoing claims for state unemployment programs totaled 1.224 million for the week ending October 15th, an increase of 26,543 from the prior week. State continuing claims had been trending higher from mid-May through the end of July but are now trending lower over the last few weeks.
The latest results for the combined Federal and state programs put the total number of people claiming benefits in all unemployment programs at 1.251 million for the week ended October 15th, an increase of 28,929 from the prior week.
Consumer Expectations for the Future Remained Weak in October
The final October results from the University of Michigan Surveys of Consumers show overall consumer sentiment was little changed from September and remains at very low levels. The composite consumer sentiment increased to 59.9 in October, up from 58.6 in September. The index hit a record low of 50.0 in June, down from 101.0 in February 2020 at the onset of the lockdown recession. The increase for October totaled just 1.3 points or 2.2 percent, leaving the index about 10 points above the record low. The index remains consistent with prior recession levels.
The current-economic-conditions index rose to 65.6 versus 59.7 in September. That is a 5.9-point or 9.9 percent increase for the month. This component has had a notable bounce from the June low of 53.8 but remains consistent with prior recessions.
The second component — consumer expectations, one of the AIER leading indicators — fell 1.8 points to 56.2. This component index posted a strong bounce in August but was unchanged in September and fell slightly in the most recent month. The index is still consistent with prior recession levels.
According to the report, “With sentiment sitting only 10 index points above the all-time low reached in June, the recent news of a slowdown in consumer spending in the third quarter comes as no surprise.” The report adds, “This month, buying conditions for durables surged 23% on the basis of easing prices and supply constraints. However, year-ahead expected business conditions worsened 19%. These divergent patterns reflect substantial uncertainty over inflation, policy responses, and developments worldwide, and consumer views are consistent with a recession ahead in the economy.” Furthermore, “While lower-income consumers reported sizable gains in overall sentiment, consumers with considerable stock market and housing wealth exhibited notable declines in sentiment, weighed down by tumult in those markets. Given consumers’ ongoing unease over the economy, most notably this month among higher-income consumers, any continued weakening in incomes or wealth could lead to further pullbacks in spending…”
The one-year inflation expectations rose in October, rising to 5.0 percent. The jump follows a string of declines over the five months through September after hitting back-to-back readings of 5.4 percent in March and April.
The five-year inflation expectations also ticked up, coming in at 2.9 percent in October. Despite the uptick, the result is well within the 25-year range of 2.2 percent to 3.4 percent. The report states, “The median expected year-ahead inflation rate rose to 5.0%, with increases reported across age, income, and education. Last month, long run inflation expectations fell below the narrow 2.9-3.1% range for the first time since July 2021, but since then expectations have reverted to 2.9%. Uncertainty over inflation expectations remains elevated, indicating that inflation expectations are likely to remain unstable in the months ahead.”
Consumer Confidence Fell in October
The Consumer Confidence Index from The Conference Board fell in October following two consecutive monthly gains. The composite index decreased by 5.3 points, or 4.9 percent, to 102.5. The index is down 8.2 percent from September 2021 and 20.5 percent from the cycle peak of 128.9 in June 2021. Both components declined in October.
The expectations component dropped 1.4 points, or 1.8 percent, to 78.1 while the present-situation component – one of AIER’s Roughly Coincident Indicators – sank 11.3 points, or 7.5 percent, to 138.9. The present situation index is off 4.5 percent over the past year while the expectations index is down 12.2 percent from a year ago. The present situation index remains at a historically favorable level. However, the sharp decline in October suggests economic growth may be slowing, while the expectations index remains consistent with prior recessions.
Within the expectations index, all three components weakened versus September. The index for expectations for higher income gained 0.6 points to 18.9, but the index for expectations for lower income rose 1.3 points, leaving the net (expected higher income – expected lower income) down 0.7 points to 3.8.
The index for expectations for better business conditions rose 0.6 points to 19.2, while the index for expected worse conditions rose 1.4 points, leaving the net (expected business conditions better – expected business conditions worse) down 0.8 points at -4.1.
The outlook for the jobs market also deteriorated in October as the expectations for more jobs index increased 2.4 points to 19.8, but the expectations for fewer jobs index rose by 3.0 points to 20.8, putting the net down 0.6 points to -1.0.
Current business conditions and current employment conditions fell for the present situation index components. The net reading for current business conditions (current business conditions good – current business conditions bad) was -6.5 in October, down from -0.2 in September and the weakest result since July. Current views for the labor market saw the jobs hard to get index increase to 12.7 while the jobs plentiful index fell 4.0 points to a still solid 45.2. The net index (jobs hard to get – jobs plentiful) dropped 5.6 points to 32.5.
Inflation expectations ticked up slightly, rising 0.2 percentage points to 7.0 percent in October from 6.8 percent in September. The rise was largely a function of higher food and gasoline prices. Notably, the short-term inflation expectations remain below the recent peaks of 7.9 percent in March and June 2022. Furthermore, while the pattern of movements between The Conference Board measure and a similar measure from the University of Michigan Survey of Consumers, the overall level from the Michigan survey is much lower (though still elevated), and importantly, the longer-term inflation expectations survey from Michigan remains well anchored and consistent with results seen over the last 25 years.
