FLAHERTY & CRUMRINE DYNAMIC PREFERRED AND INCOME FUND INC. Second-Quarter U.S. Economic Update
August 2022
Summary of Recent Economic and Market Developments
The U.S. economy contracted slightly again in the second quarter. Overall real GDP fell 1.6%, and personal spending was the only major sector that recorded real growth. Hiring slowed but still averaged 384,000 job gains per month, and job openings remain elevated. Personal income rose moderately, with strong gains in wages and salaries, but failed to keep pace with inflation. Real personal consumption expenditures rose 1.0% in Q2, down from 1.8% in Q1 as consumers coped with sharply higher energy and food prices. Home sales fell as higher prices and mortgage rates hit demand, pushing real residential investment down 14%. Industrial output (+6.1%) had another strong quarter, but business investment fell slightly on weaker structures and equipment investment. Other sectors-trade (+1.4%), inventories (-2.0%), and government consumption (-0.3%)-together contributed -0.9% to real GDP.
Inflation remained very high, with food and energy prices up sharply. Year-over-year CPI reached a high of 9.1% in June before falling back to 8.5% in July, and the PCE deflator rose 6.8% YoY in June. Core inflation (excluding volatile food and energy prices) eased somewhat. Core CPI rose 5.9% YoY in July, down from a peak of 6.5% in March. The core PCE deflator was up 4.8% YoY in June, down from a peak of 5.3% in February. While the improvement in core inflation is good news, the employment cost index of wages and salaries, median CPI, housing inflation, and the Atlanta Fed's "Sticky" CPI all hit new YoY highs. We do not expect to see much progress on inflation until the fourth quarter.
The Fed hiked the fed funds rate by 125 bp in Q2 and another 75 bp in July to bring the fed funds target range up to 2.25-2.50%. Market forward rates show the fed funds rate peaking around 3.5% at year-end, holding steady until mid-2023, and falling in the second half of 2023 through 2024-to well below the Fed's projections. Yields on intermediate-term Treasuries rose sharply in Q2-peaking in mid-June-and declined substantially since then. Credit spreads behaved similarly. Lower rates and narrower credit spreads so far in Q3 have given credit index returns a welcome boost after a dreadful first half of 2022.
Although we anticipate a mild recession sometime after mid-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.
Author's note: We recently changed the presentation of our Economic Update, organizing it by major economic sectors and markets. Most economic and market data now appear in tables and graphs, while accompanying prose focuses on explanation and analysis. In the data tables, we use green shading to highlight indicators that improved from the prior period, red shading on those that deteriorated, and no shading on indicators that were little changed. We hope you find the new format more readable and useful.
Second-Quarter U.S. Economic Update | Page 1 | August 15, 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 | 2022:2 | 2022:1 | 2021* | 2020* | 2022:2 | 2022:1 | 2021* | 2020* | 2022:2 | 2022:1 | 2021* | 2020* |
Gross Domestic Product (GDP) | -0.9% | -1.6% | 5.5% | -2.3% | 7.8% | 6.6% | 11.8% | -1.0% | 8.9% | 8.3% | 5.9% | 1.3% |
Personal Consumption Expenditures | 1.0% | 1.8% | 6.9% | -2.4% | 8.2% | 9.0% | 12.8% | -1.3% | 7.1% | 7.1% | 5.5% | 1.2% |
PCE: Goods | -4.4% | -0.3% | 7.3% | 7.7% | 5.3% | 11.4% | 16.1% | 7.2% | 10.2% | 11.8% | 8.2% | -0.5% |
PCE: Services | 4.1% | 3.0% | 6.7% | -6.9% | 9.7% | 7.7% | 11.1% | -5.1% | 5.4% | 4.6% | 4.1% | 2.0% |
Fixed Investment | -3.9% | 7.4% | 4.4% | 0.5% | 5.3% | 17.9% | 10.7% | 2.2% | 9.6% | 9.8% | 6.0% | 1.7% |
Business Investment | -0.1% | 10.0% | 6.6% | -3.8% | 8.1% | 17.6% | 10.2% | -3.0% | 8.1% | 7.0% | 3.4% | 0.8% |
Structures | -11.7% | -0.9% | -2.6% | -20.0% | 2.2% | 17.2% | 8.9% | -19.4% | 15.8% | 18.2% | 11.8% | 0.7% |
Equipment | -2.7% | 14.1% | 6.5% | -0.3% | 5.3% | 22.2% | 9.2% | -1.1% | 8.2% | 7.1% | 2.6% | -0.8% |
Intellectual Property | 9.2% | 11.2% | 11.5% | 2.5% | 14.1% | 13.2% | 12.0% | 5.3% | 4.5% | 1.8% | 0.4% | 2.7% |
Residential Investment | -14.0% | 0.4% | -1.5% | 15.7% | -2.2% | 18.7% | 11.9% | 21.0% | 13.7% | 18.2% | 13.6% | 4.6% |
Government Consumption | -1.9% | -2.9% | 0.1% | 1.2% | 9.5% | 6.6% | 6.4% | 3.0% | 11.6% | 9.8% | 6.3% | 1.8% |
Federal | -3.2% | -6.8% | -1.1% | 3.1% | 2.9% | 0.2% | 3.6% | 4.9% | 6.3% | 7.5% | 4.7% | 1.7% |
State & Local | -1.2% | -0.5% | 0.8% | 0.0% | 13.6% | 10.7% | 8.2% | 1.9% | 14.9% | 11.2% | 7.3% | 1.9% |
Domestic Final Sales | -0.3% | 2.0% | 5.3% | -1.3% | 7.9% | 10.1% | 11.3% | 0.1% | 8.2% | 8.0% | 5.7% | 1.4% |
Private Domestic Final Sales | 0.0% | 3.0% | 6.4% | -1.8% | 7.6% | 10.8% | 12.3% | -0.6% | 7.6% | 7.6% | 5.6% | 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.
The U.S. economy in the second quarter posted stronger nominal GDP growth, higher inflation, and weak real GDP growth (Figure 1). While not quite as bad as Q1, real GDP growth was again negative. Moreover, the composition of growth deteriorated, with real domestic final sales (overall and private) flat to down during the period. This is what stagflation looks like. Except for residential investment, nominal GDP rose strongly across major sectors- albeit at a slower pace than in Q1 in most cases-but inflation either remained high or worsened. After inflation, personal consumption expenditure on services was a highlight, while residential investment slumped, and business investment slowed. Real government consumption fell for the third consecutive quarter. The table above highlights that the U.S. economy does not have a demand problem-nominal spending remains impressive-it has an inflation problem.
Following disappointing growth in the first half of the year, economists forecast U.S. real GDP will expand by just 1.6% in 2022 and 1.1% in 2023, down from 2.7% and 2.1%, respectively, in the May survey.1 For the second half of this year, GDP is forecast to grow by 1.5% in Q3 and 1.4% in Q4. Tighter monetary policy in the U.S. and slowing demand are expected to bring down year-on-year PCE inflation from 4.8% in 2Q2022 to 4.5% in 4Q2022, 2.9% in 4Q2023 and an average of 2.4% in 2024.
We admit that forecasting real GDP growth is exceptionally difficult currently. We think nominal GDP growth will slow modestly over coming quarters as consumers deplete savings from the pandemic and pare spending, residential investment remains subdued, and business investment slows. We are less sure about how quickly inflation comes down. If inflation falls quickly next year, the real GDP forecasts above will probably be too low. If inflation is stickier (our base case), the Fed will have to tighten more or leave rates at a restrictive level for longer than markets currently expect, and the economy could slip into
- Bloomberg Monthly Economic Survey, August 12, 2022, Bloomberg L.P.
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recession. The consensus forecasts above imply that the Fed will engineer an economic "soft landing" by reducing core PCE inflation close to its 2% long-term target over the next several years while avoiding a recession. We continue to think that will be a very difficult task and expect a mild recession beginning in the second half of 2023 or in 2024. However, we still do not see excessive investment in homes, inventories, or plant and equipment that typically leads from boom to bust. If a recession arrives, it 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) | Jul-22 | Jun-22May-22 | 2022:2 | 2022:1 | 2021:4 | Jul-22 | Jun-22 | Feb-20 | |
Nonfarm Payrolls | 528 | 398 | 386 | 1,152 | 1,616 | 1,912 | 4.2% | 4.3% | 32 |
Private | 471 | 404 | 331 | 1,103 | 1,581 | 1,882 | 4.8% | 4.9% | 629 |
Household Employment | 179 | (315) | 321 | (347) | 2,483 | 2,169 | 3.6% | 4.2% | (576) |
Labor Participation Rate % | 62.1% | 62.2% | 62.3% | -0.2% | 0.5% | 0.2% | 0.4% | 0.6% | -1.3% |
Unemployment Rate | 3.5% | 3.6% | 3.6% | 0.0% -0.3%-0.8% | -1.9% | -2.3% | 0.0% | ||
MoM% Change | QoQ% Change, AR | YoY% Change | |||||||
Average Hourly Earnings | Jul-22 | Jun-22May-22 | 2022:2 | 2022:1 | 2021:4 | Jul-22 | Jun-22 | Feb-20 | |
Average Hourly Earnings, All | 0.47% | 0.44% | 0.38% | 4.7% | 4.8% | 6.1% | 5.3% | 5.2% | 3.7% |
QoQ% Chg (not annualized) | YoY% Change | ||||||||
Employment Cost Index | 2022:2 | 2022:1 | 2021:4 | 2021:3 | 2022:2 | 2022:1 | 2021:4 | 2021:3 | 2019:4 |
Employment Cost, Total, Civilian | 1.3% | 1.4% | 1.0% | 1.2% | 5.1% | 4.5% | 4.0% | 3.7% | 2.7% |
The labor market slowed in the second quarter but continued to add jobs at an impressive pace. Moreover, nonfarm payrolls rose 1.15 million in Q2 and added 528,000 jobs in July, pushing payrolls above their prior peak in February 2020, just before the COVID-19 pandemic caused employment to plunge (Figure 2). Similarly, the unemployment rate dipped to 3.5% in July, equaling its pre-pandemic level. However, the household employment survey, which had outpaced the payroll survey for several quarters, recorded job losses in Q2 and only a modest gain in July, leaving it 576,000 jobs below its February 2020 peak. While the two surveys track closely over longer periods, they can diverge over shorter periods. In general, we put more weight on the much larger payroll survey, and that remains the case now. However, sustained weakness in the household survey (which produces the unemployment rate) may signal a turning point in hiring, and it bears watching.
Figure 3: Labor Market Still Tight; Wages Up
U.S. Wage Growth and Unemployment Rate | |||||||
15 | 9 | ||||||
14 | 8 | ||||||
13 | YoY | ||||||
12 | 7 | ||||||
Percent | 11 | 6 | orWage | ||||
Rate,Unemployment | 10 | 5.3 | PercentGrowth,Earnings | ||||
5.2 | |||||||
9 | |||||||
8 | 4 | ||||||
7 | 3 | ||||||
6 | |||||||
2 | |||||||
5 | |||||||
4 | 1 | ||||||
3.5 | |||||||
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
Figure 4: Savings Keeping Spending Up
Nominal Personal Income, Consumption and Savings, YoY | ||||||||||||
35 | 30 | |||||||||||
25 | ||||||||||||
30 | 20 | |||||||||||
PercentGrowth,Spending& Income | ||||||||||||
PercentRate,Savings | 25 | 15 | ||||||||||
10.3 | ||||||||||||
8.4 | ||||||||||||
20 | 5.7 | |||||||||||
0 | ||||||||||||
15 | -5 | |||||||||||
10 | -10 | |||||||||||
-15 | ||||||||||||
5 | 5.1 | |||||||||||
Jan | Apr | Jul | Oct | Jan | Apr | Jul | Oct | Jan | Apr | Jul | ||
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
Second-Quarter U.S. Economic Update | Page 4 | August 15, 2022 |
While prospects for continued job growth remain good, the current pace of gains is bound to slow. Job openings declined for the third consecutive month in June, bringing the ratio of job openings to unemployed persons down to 1.81 from a high of 1.99 in March. That ratio is still very high historically, however. Even in February 2020, when the unemployment rate equaled today's 3.5%, the ratio of job openings to unemployment was 1.23. Unsurprisingly, both the employment cost index and hourly earnings continued to rise faster than when unemployment was at a similar level before the pandemic (Figure 3). Although higher wages usually are welcome, they add to production costs and may contribute to inflation becoming entrenched, if not offset by higher labor productivity-which has been weak this year. Tighter monetary policy and a slower pace of hiring should begin to dampen wage growth, but with job openings still elevated, we think it will take several more quarters to have an impact. Sticky wage growth would make the Fed's job considerably more difficult.
Figure 5: Personal Income and Spending
Personal Income and | MoM Change | QoQ Change (AR) | YoY Change | ||||||
Consumption | Jun-22May-22Apr-22 | 2022:2 2022:1 2021:4 | 2022:2 2022:1 2021:2 | ||||||
Personal Income | 0.62% | 0.60% | 0.45% | 6.8% | 4.8% | 3.6% | 4.6% | -2.8% | 1.6% |
Wages & Salaries | 0.46% | 0.56% | 0.50% | 7.6% | 9.8% | 13.7% | 10.9% | 12.2% | 13.4% |
Real Disposable Pers. Inc. | -0.30% | 0.01% | 0.19% | -0.5% | -7.8% | -4.5% | -4.3% | -12.0% | -4.3% |
ex Transfer Payments | -0.28% | 0.15% | 0.33% | 1.0% | 0.0% | 2.9% | 1.8% | 2.8% | 6.9% |
Nominal PCE | 1.07% | 0.26% | 0.48% | 8.2% | 9.0% | 9.0% | 8.4% | 11.1% | 20.7% |
excl. Food & Energy | 0.85% | 0.12% | 0.69% | 7.1% | 7.6% | 8.3% | 7.4% | 10.4% | 21.6% |
Goods | 1.63% | -0.75% | 0.17% | 5.3% | 11.4% | 11.4% | 6.4% | 10.7% | 27.1% |
Services | 0.78% | 0.79% | 0.64% | 9.7% | 7.7% | 7.8% | 9.5% | 11.3% | 17.5% |
Real PCE | 0.12% | -0.33% | 0.26% | 1.0% | 1.8% | 2.5% | 1.8% | 4.5% | 16.3% |
Personal income grew strongly in nominal terms in Q2, but, once again, high inflation pushed real disposable personal income growth into negative territory, albeit less so than in Q1 (Figure 5). Excluding the impact of substantially lower transfer payments, real disposable personal income rose modestly in Q2. Gains in hourly pay and employment drove 10.3% annual and 7.6% quarterly gains in wage and salary income (Figures 4 and 5, respectively), although inflation pared them to only modest increases in real terms. Looking ahead, we expect further slowing in nominal personal income growth, partially offset by a gradual decline in inflation, leaving U.S. households with modestly lower real disposable personal income as tighter monetary policy cools the labor market.
Nominal personal consumption expenditure (PCE) slowed slightly in the second quarter but remained very strong (Figure 4). Goods spending slowed significantly, while services expenditure accelerated (Figure 5). After inflation, real PCE growth was up just 1.0% in Q2. Although U.S. consumers continue to see higher wages and good job availability, high inflation-especially sharply higher gasoline prices in Q2-and ongoing worries over war in Ukraine crushed consumer confidence during the quarter. The University of Michigan's consumer sentiment survey reached a record low in June of 50, although it improved slightly to 51.5 in July as energy prices dropped (Figure 6). The Conference Board survey does not look as dire, but it too dropped sharply during the quarter. Weaker confidence has not
Second-Quarter U.S. Economic Update | Page 5 | August 15, 2022 |
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Flaherty & Crumrine Dynamic Preferred and Income Fund Inc. published this content on 18 August 2022 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 18 August 2022 22:13:00 UTC.
