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North America Macroeconomic Update: Slowing Growth, Slowing Inflation

DBRS Morningstar released its semiannual North America Macroeconomic Update. While third quarter headline GDP growth figures suggest that the U.S. and Canada continued to grow at a strong pace, the composition of growth reveals that both economies are slowing amid rapidly rising interest rates. Headline inflation has peaked but strong cost pressure for services could slow the pace of disinflation, particularly as labor markets remain exceptionally tight. Against this backdrop, the monetary tightening cycles in the U.S. and Canada are coming to an end.

Key highlights:

-- The prognosis for growth in 2023 is weak. While labor markets are still tight and household balance sheets are generally strong, we expect consumers to be more discerning in their spending decisions going forward. Residential investment, which has already contracted for several quarters, will continue to be weighed down by the ongoing housing market adjustment. Exports will face weakening global demand. Taken together, we expect the U.S. and Canada to run close to stall speed for the first 2-3 quarters of 2023 before returning to moderate growth.

-- Core inflation is already moderating or is set to moderate in two key areas: core goods and shelter. The combination of these forces bode well for the inflation outlook for 2023, even as the strength of non-shelter services could slow the pace of disinflation.

-- The monetary tightening cycle is coming to an end. The Federal Reserve projects that the federal funds rate will increase another 75 basis points in early 2023. The Bank of Canada has signaled that future policy rate decisions will be data dependent.

“With economic growth expected to stall in early 2023, a technical recession is a clear possibility,” says Michael Heydt, Senior Vice President, Global Sovereign Ratings. “However, if the U.S. or Canada enter recession, we expect it to be short and shallow. That said, risks are skewed to the downside. In particular, persistent and strong wage growth may lead to additional and more prolonged monetary tightening, thereby worsening the downturn.”