Where the economy is showing signs of slowing near recession levels

Where the economy is showing signs of slowing near recession levels

Fed's Demonstrated Willingness to Take Extreme Measures, Says Macropolicy Perspectives' Coronado

Inflation continues to suck much of the oxygen out of earnings calls, and whether it’s Pepsico doing more with less unit volume or Apple finding the right time to demand more from service subscribers, larger companies still have the ability to pass on price increases to customers, and many expect this to continue. But at an economy-wide level, recent data has shown that leading sales and earnings indicators warn of a potential recession.

A closely watched survey by the National Association for Business Economics showed a drop in business sales that hasn’t been so steep since the Covid crash in mid-2020 and is approaching a level that matches several past recessions. The Net Increase Index (NRI) in sales – the percentage of survey respondents reporting an increase in sales minus the percentage reporting a decrease in sales – peaked at 74% of businesses in April 2021. In October, it was dropped to 36%.

“That doesn’t mean the majority of companies are forecasting a decline, but it’s enough to be concerning,” Julia Coronado, founder of MacroPolicy Perspectives, former Fed economist and current chair of NABE, told us. “This index is near recession levels, but not near recession levels, although many companies are doing well,” Coronado said.

NABE has been tracking this data since the 1980s.

According to another NABE measure, the Net Rising Index of Profit Margins, the recession is here.

Coronado advises companies to focus on declining sales. This is because profit margins tend to be more volatile and it is sales, as on-demand reading, that drive the economy. “It’s a little more reliable, and it flashes yellow to red. It’s not over the edge, just closer to the edge,” she said.

NABE data has both good and bad news for the Fed and businesses. Materials costs associated with supply chain inflation are at record highs and have fallen 24 percentage points from a record high in July. These are the lowest material costs since April 2021, and this is one of the strengths the Fed needs as an ally to calm inflation across the economy.

But the labor market is still not cooperating. The net wage increase index reached its third highest value on record, surpassed only in January and April this year.

“They keep raising salaries and still try to pass on the higher costs,” Coronado said.

Friday’s latest jobs report showed a slight rise in unemployment, but job growth that remained stronger than expected and rising wage growth as well.

Sixty-nine percent of NABE survey respondents indicated that some or all of the costs are passed on.

A person shops at a supermarket as inflation hits consumer prices in New York City on June 10, 2022.

andrew kelly | Reuters

Labor costs and hiring expectations have fallen in the NABE survey, but in Coronado’s data analysis, there is still not enough to convincingly prove that the Fed will reduce the magnitude of the rate hikes more than the market expects, although NABE data suggests leading indicators should get more attention. The Fed hinted in formal language last week that it might consider slowing its rate hikes if the data warranted it, but Fed Chairman Jerome Powell’s press conference after the FOMC meeting muddied the picture, with Powell giving little indication that tight monetary policy would soon change. and the fight against inflation remaining a central concern.

“Obviously, there are signs that the Fed’s policy is having the desired effect and we are entering a zone where you can ask yourself: ‘Is it having enough effect? they go?’ … You don’t keep raising rates until the economy cracks,” Coronado said of the NABE data. “If you see enough leading indicators moderating, you can let those higher rates take effect. You apply the brake and let it pass, maybe go down to 50 basis points and then 25. Rates continue to rise. increase, borrowing costs continue to rise and demand continues to slow,” she added.

The market is expecting a 50 basis point hike at the December FOMC meeting.

Regardless of what the Fed does, the demand picture means the road will be tougher for many companies with big productivity and pricing decisions to make to retain market share. The relief that is showing on the supply side, in data such as input costs, will be factored into the decisions companies will have to make as sales growth cools. “Do they want to keep their margins and not pass on this relief in input costs,” asked Coronado. “It may be better for stability in market share to give some relief to the consumer. It may be better for stability in the business cycle as a whole.”

Earnings and sales outlook dim as companies face challenging environment

Companies are still testing the limits of pricing power. NABE data shows that even though the goods sector is seeing the biggest drop in sales outlook, 88% of companies still say they have some pricing power. “Maybe they’re not reading the writing on the wall,” Coronado said.

What she sees with certainty in the data is a “pronounced change” from the start of the year, but a consumer and a Fed that remain difficult to identify.

“Obviously the economy is slowing down, sales are slowing down and the pressure on margins is real,” she said. “It comes out loud and clear.”

But with wages continuing to rise, even if they don’t keep up with inflation, supply-side declines may require more help from the demand side before the Fed can change its point of departure. seen. “It’s a one-economy liner and as long as people have jobs and an income, it won’t go overboard,” she said.

After the Fed continued its 75 basis point hike this week, the question is how flexible the central bank will be in the face of a slowdown – how much signal it is getting from leading indicators.

“It’s just such an uncertain environment, and they got enough things wrong enough that they didn’t beat the table on their forecast,” Coronado said.

Fed members will say “we’re getting closer to the rate to restrain the economy” — and in fact several Fed chairs said that on Friday — but it will continue to be complicated by a Fed view that Coronado says , can be summed up as, “we need to see more.”

“There’s no question the Fed doesn’t think it’s done enough to defeat inflation and the question is really nuanced,” Coronado said in an interview with CNBC last week. “There’s no nuance on a pivot or a rate cut, but it’s around the pace. It’s pretty limited nuance around a very hawkish path.”

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