Vulnerable U.S. economy faces test
OPEC+ announced a significant cut to its collective output limit, just as the U.S. economy is vulnerable and financial market conditions have tightened. The reduction of 2 million barrels per day is the largest since 2020 and will remain in place until the end of 2023, unless there are material changes in markets. A number of OPEC+ countries are already operating below their quotas, therefore the hit to output should be less. Still, West Texas Intermediate and Brent crude oil prices were trading higher following the announcement.
There could be some modest implications for the U.S. high-yield corporate bond market. In our past work, we used Granger causality tests to see if there is a causal relationship between the high-yield corporate bond spread and WTI crude oil prices. With no lags, fluctuations in WTI crude oil prices were found to Granger-cause changes in the high-yield corporate bond spread. The results showed that the causality runs one way, which isn’t surprising. Highyield spreads have tightened in the past couple of trading sessions and some further improvement is likely. Elsewhere, the implications for our U.S. baseline forecast are likely minor. It introduces upside risk to the near-term forecast for growth in consumer prices. Energy prices only needed to remain unchanged to be disinflationary, but the OPEC+ decision adds more uncertainty to the near-term path for oil and retail gasoline prices.
We likely won’t have to make a significant revision to our forecast for near-term GDP growth because of Wednesday’s decision. A $10-per-barrel increase in the price of oil would shave only 0.1% from U.S. real GDP growth over the subsequent year.
Q3 being kept afloat by trade
The U.S. trade deficit narrowed in August, and net exports will add more to thirdquarter GDP growth than previously thought. The nominal trade deficit narrowed from a revised $70.5 billion (previously $70.7 billion) in July to $67.4 billion in August.
Nominal exports fell 0.3% in August after they had been steadily increasing. Nominal imports were down 1.1%, the third consecutive monthly decline. The nominal goods deficit narrowed while the services surplus fell modestly. The real goods deficit narrowed from $103.1 billion to $98.95 billion.
Through August, the nominal trade deficit is averaging $68.95 billion in the third quarter, compared with the $84.5 billion in the second quarter. Our high-frequency GDP model now has net exports adding 1.8 percentage points to third-quarter GDP growth. All told, third-quarter GDP growth is now on track to rise 2.2%, compared with 1.8% prior to the August trade deficit.
Just as we downplayed some of the weakness in GDP in the first half of the year because of a noticeable drag from net exports and inventories, don’t get too excited about growth in the third quarter. Excluding net exports, GDP is on track to rise only 0.4% at an annualized rate. Consumer spending is coming in light, and residential and nonresidential structures investment will be weights.
Watching the Beveridge Curve?
The Fed needs to tighten monetary policy sufficiently to slow GDP growth to a belowpotential pace. This will rebalance supply and demand in the labor market enough to bring down wage growth, then inflation. The August Job Openings and Labor Turnover
Survey data suggest that the weakness in GDP and heightened concerns about a recession could be cutting into the demand for labor.
We have updated the Beveridge curve through August. The Beveridge curve is the relationship between the job openings rate and the unemployment rate. The economy’s position on the Beveridge curve reflects the state of the business cycle. The Fed’s preferred path toward a soft landing is for the job openings rate to decline without translating into an increase in the unemployment rate, so that the Beveridge curve doesn’t shift out. Currently, the Beveridge curve has shifted out modestly.As the Fed continues to tighten monetary policy, labor demand will weaken further and more workers should be laid off. The path toward a soft landing is via a reduction in job openings with a minimal, if any, increase in the unemployment rate. This is a narrow path.
Per Okun’s law, a 1-percentage point deceleration in GDP growth over the course of a year would trim employment growth by around 800,000 jobs per annum. This would also increase the unemployment rate by about 0.5 percentage point and shave a few basis points off year-over-year growth in both the consumer price index and PCE deflator.