Michael Skordeles AIF® is Senior U.S. Macro Strategist for Truist Wealth.
The U.S. economy remains strong, powered by a robust labor market that’s feeling pressure from the escalation of the Russia-Ukraine conflict, which is spiking energy prices. Healthy consumers that a thriving economy supports are good news for automotive retailers looking to continue their run of exceptional performance.
When the pandemic, closings, and health restrictions slammed the brakes on the economy, we hoped for a fast recovery, but we never expected it to be smooth—and we were right. As we look at the key economic elements, inflation is a constant thread, and the Federal Reserve’s (Fed) fight to control the pace of the economy will be part of the economic storyline for the immediate term.
A robust job market spurs both inflation and growth.
The U.S. is running at full employment as the unemployment rate fell to 3.6%, in line with December 2019. Private payrolls increased by 426,000 workers in March 2022, while government payrolls rose by 5,000 as sizable numbers returned to the labor force. Every labor market indicator, including initial jobless claims, job openings, quit rates, and others point to the strength of the labor market.
Wage and income growth increased as average hourly earnings rose 5.6% from a year ago. That’s well above the 2019 average of 3.3% and double the 2.4% average for the decade before the pandemic (2009 through 2019). Gains are even stronger for rank-and-file workers—the bulk of all employees—who are seeing increases of 6.7% year over year.
Wage gains are a double-edged sword—while they push inflation higher in the short term, they also drive gross domestic product (GDP) growth somewhat higher in the next year. Wage gains should be a modest net positive for long term growth.
Average hourly earnings of production & nonsupervisory employees
Economic data remains strong.
Demand remains robust, which implies further growth rather than recession. Look at weekly jobless claims, the unemployment rate, housing starts, building permits, and manufacturing surveys—all those indicators are pointing toward continued economic growth (and inflation) rather than signaling recessionary conditions. We expect GDP growth of 2.2% year over year, marked down to account for hotter inflation and faster-than-expected Fed hikes in 2022.
Credit quality continues to normalize, up from the all-time lows that primarily affected low credit score consumer in 2021. Still, overall credit quality remains stellar considering the pandemic.
Inflation is “the” hot button issue for consumers and businesses.
The inflation that we’re seeing today will likely persist, especially with already high energy prices being further aggravated by the Russian invasion.
Outside of energy, other upward inflationary pressures are generally cooling. For example, rents are moderating from a red-hot 2021, used car prices have declined for two months (February and March), and wage pressures have softened.
While we expect overall inflation pressures to ease later this year as production and supply chains recover and consumer spending shifts back towards services, for 2022, we’re projecting the Consumer Price Index (CPI) to rise 6.8%.
Watching the Federal Reserve and stock market
The Fed will remain laser focused on inflation, and the hotter inflation readings have bolstered its stance. That translates to faster-than-expected rate hikes in 2022 to combat inflation and also reduces growth, on the margin, by increasing borrowing costs, particularly for big-ticket purchases.
We now expect the Fed funds rate to be 1.75% to 2.00% by year end 2022, and 2.50% to 2.75% by year end 2023. Furthermore, we expect the Fed to allow balance sheet runoff at a pace of $80 billion - $100 billion per month beginning this summer.
While the Fed has signaled its resolve to take on inflation, we believe talk about the Fed “overtightening” – causing a recession – is misplaced. The Fed has many levers to pull, including reducing its balance sheet, as well as adjusting the speed and size of rates changes.
When it comes to the stock market, we expect stock price and yield volatility will likely persist for much of 2022. Between Russia, energy prices, inflation, recession fears, Fed tightening, profit margins, earnings, and mid-term elections later this year, investors can’t easily get a “clean” read on conditions. That’s a recipe for continued volatility.
Consumer strength
The automotive supply shortage is expected to continue for some time due to continued supply chain issues for manufacturers, keeping vehicle prices elevated. Demand should also remain solid so long as the consumer wage growth stays strong and able to absorb elevated car prices and financing costs from higher interest rates. The risk to watch is a recession, and while we see hotter inflation readings lingering for longer and inflation-adjusted growth will be lower in 2022, we don’t see the makings of a recession at present. All indicators point toward an economy that is strong and running too hot, not one headed for a recession. For dealerships and for the economy as a whole, that’s great news.
Keep a close eye on inflation and interest rates.
Talk to your Truist Dealer Services relationship manager about how you can prepare your dealership for an economy that’s running hot.