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Economic Risk Factor Update: April 2022

Written by Brad McMillan, CFA®, CFP® | Apr 6, 2022 7:32:00 PM

My colleague Sam Millette, manager, fixed income on Commonwealth’s Investment Management and Research team, has helped me put together this month’s Economic Risk Factor Update. Thanks for the assist, Sam!

The economic reports released last month showed continued growth throughout the first quarter despite the shifting risks to start the year. The March employment report showed that the pace of hiring remained strong during the month, which was an encouraging sign that the economic recovery remains healthy. Additionally, service sector and consumer confidence both showed modest improvements, which is a good sign for spending.

On the medical side, daily new case growth continued to drop in March. Average daily new cases ended the month at their lowest level since July 2021, as high levels of vaccination and natural immunity from previous exposures helped contain the spread of the Omicron variant. Overall, the recent wave's medical risks, and their economic impact, appear to be behind us.

Despite the ongoing improvements, the risks from inflation, the Fed’s plans for tighter monetary policy, and the uncertainty caused by the Russian invasion of Ukraine remain. We have left the overall risk level at a yellow light for now. That said, if we see the risks decline in the short term, the economic momentum could lead to quick upgrades in the months ahead.

The Service Sector

Signal: Yellow light

Service sector confidence increased modestly in March, as the ISM Services index rose from 56.5 in February to 58.3 in March against calls for an increase to 58.5. While this was an improvement over February’s result, it still left confidence well below the recent highs we saw late last year. This is a diffusion index where values above 50 indicate growth, so this result still signals continued expansion.

While confidence remains in expansionary territory, the recent relative weakness of the index is a potential cause for concern and highlights the challenges that businesses are facing due to rising prices and labor shortages. Given the fact that the index remains near a one-year low, we have left this indicator as yellow for now.

Private Employment: Annual Change

Signal: Green light

March’s employment report showed that 431,000 jobs were added during the month, below the 490,000 jobs that were projected but still strong on a historical basis. The January and February job reports were also revised upward by an additional 95,000 jobs. The strong March result and the positive revisions to past reports indicate that the labor market recovery continued at a healthy pace throughout the first quarter despite the shifting risks over the past few months.

The underlying data was also encouraging. The unemployment rate fell from 3.8 percent in February to 3.6 percent in March, which marks a new low since the start of the pandemic. Wage growth also increased on a monthly and year-over-year basis, highlighting a positive impact for workers in the tight job market.

Given the strong results in March and positive revisions to the previous job reports, we have kept this signal at a green light for now.

Yield Curve (10-Year Minus 3-Month Treasury Rates)

Signal: Green light

The yield curve widened slightly in March, and this was caused by long-term rates rising faster than short-term rates during the month. The 3-month Treasury yield increased from 0.35 percent at the end of February to 0.55 percent at the end of March. The 10-year Treasury yield rose from 1.83 percent at the end of February to 2.32 percent at the end of March.

The rise in both short- and long-term yields was primarily due to rising expectations for rate hikes from the Fed throughout the year as well as high levels of consumer and producer inflation.

Economists expect to see the Fed focused on combating inflation in 2022, which could lead to more frequent rate hikes as the central bank tries to normalize monetary policy. While tighter monetary policy could lead to market volatility, it is an encouraging signal that the Fed views the economy as healthy enough to endure a faster return to normal.

Given the fact that the spread between the 3-month and 10-year Treasury rates remains near September and October levels and well outside of the historical inversion danger zone, we have left this signal at a green light for now.

Consumer Confidence: Annual Change

Signal: Yellow light

Consumer confidence rose modestly from a downwardly revised 105.7 in February to 107.2 in March against calls for an increase to 107. On a year-over-year basis, confidence declined 6.7 percent in March, which is down from the 11 percent increase we saw in February.

Historically, declines in confidence of 20 percent or more over the past year are a signal of a recession; the fact that the year-over-year figure remained outside the historical danger zone in March was reassuring. That said, this marks the first year-over-year decline in confidence since March 2021, so this will be an important area to monitor in the coming months.

Given the fact that confidence declined on a year-over-year basis in March, we have downgraded this indicator to a yellow light, although further year-over-year declines in the months ahead could lead to another downgrade.

Conclusion: Solid Fundamentals, but Risks Remain

The economic data releases for March continued to show signs of economic growth despite concerns about inflation and the Russian invasion of Ukraine. Looking forward, further economic growth remains the most likely path forward. But, as we’ve seen throughout the pandemic, there are real risks that remain in this outlook.

The continued strong hiring growth was good news, but it’s still too early to say the job market is back to full pre-pandemic levels. The improving service sector and consumer confidence were positives during the month; however, both remain well below recent highs and should be monitored in the months ahead. Ultimately, the pace and path of the expected recovery in the short term remain uncertain. Therefore, caution is still warranted.

We have left the overall economic risk indicator at a yellow light to reflect continued uncertainty and the potential for new setbacks in the months ahead.