We’ve revised our outlook for full-year U.S. GDP growth to roughly 2%, down from around 3.5% at the start of the year.1 Three factors that will likely persist through 2022 drive our downgrade:
- Financial conditions have tightened to a level that likely restricts growth. Most of the tightening has come through higher lending rates. Falling equity markets have also contributed. We believe conditions have tightened significantly more than what’s implied by the market’s current pricing of future federal funds rate increases. Hikes eventually might even go beyond the neutral policy rate (when the Fed’s key interest rate would neither stimulate nor restrict the economy), which we currently see as around 2.5%.
- Incomes aren’t keeping pace with inflation, a drag on what have been solid consumer fundamentals. We believe that wage growth will remain elevated but will only catch up to levels of core inflation late in 2022, and will continue to lag headline inflation, which includes the effects of volatile food and energy prices.
- The foreign demand outlook has deteriorated. The war in Ukraine is hurting European economies, and persistent COVID-19 outbreaks have caused growth in China to fall well below trend. We expect U.S. net trade to be pressured as a result. A 1.5% U.S. GDP contraction in the first quarter was in no small part driven by a reduction in net trade, as exports declined and imports increased.2 The simple math of the unexpected first-quarter decline in U.S. GDP puts downward pressure on full-year GDP.
“We’re tempering expectations about growth, but that doesn’t materially change our views about the labor market or inflation at this point,” Patterson said. More moderate growth will keep the unemployment rate from falling below 3% in the near term, and high labor demand should normalize more rapidly. We continue to expect that inflation will remain elevated but falling, supported by healthy demand, a tight labor market, and supply constraints that will linger throughout the year. Persistently elevated energy prices have grown as an additional risk factor, and we will monitor that closely.
“The growth rate also doesn’t change our view on Fed monetary policy for what remains of 2022,” he added. Vanguard expects the federal funds rate to increase another 100 to 150 basis points (bps), on top of the 75 bps earlier in the year. The rate hikes will come alongside a reduction in the Fed’s balance sheet.