Labor markets continued to experience solid growth and unusual tightness in September.

Nonfarm payrolls expanded by 263 thousand on the month, down from an average of 382 thousand over the prior three months and far exceeding a pace consistent with trend growth in labor supply. The labor force declined modestly in September, and civilian employment (from the "household survey") rose 204 thousand, so the unemployment rate declined to 3.5%, matching its low for this cycle.

Hours worked rose moderately in September. Other data also point to continued strength in labor demand and tight labor markets, including low levels of initial and continuing claims for unemployment insurance and elevated job vacancies both overall and relative to the number of unemployed. Vacancies and quits have declined from recent highs but as of August were still elevated in historical context.

We expect labor markets to ease in coming quarters as the Federal Reserve continues to raise interest rates, and shrink its balance sheet, to tame inflation. Lowering inflation to 2% — the Fed's target — sustainably is unlikely without slack developing in labor and product markets. With a determined Fed and the rapid tightening of financial conditions sparked by its policy approach, a recession is likely.

Third quarter and beyond

The US was not in a recession in third quarter. Our index of monthly GDP, derived from similar data and methods used to construct the official quarterly GDP figures, surged 0.8% in August, reflecting an increase in nonfarm inventory investment and a narrowing of the trade deficit. We estimate that GDP rose at a 2.2% annual rate in the third quarter. We estimate that a sharp increase in net exports accounted for approximately 3 percentage points of GDP growth in the third quarter.

We just updated our forecast, which now includes a mild recession beginning in the fourth quarter, when we expect GDP to decline at a 1.2% annual rate. We expect GDP to continue to decline in subsequent quarters and the unemployment rate to rise to approximately 6% by the end of next year.

Bond yields drifted up last week as markets responded to strong data that pointed to positive GDP growth in the third quarter. An announcement of an agreement among "OPEC+" to curtail production of crude oil supported higher prices for crude oil and contributed to higher bond yields.

The next rate increase

In various speeches and other appearances, policymakers on the Federal Open Market Committee (FOMC) expressed continued determination to raise interest rates in pursuit of lower inflation. There is no disagreement (in public, at least) on the need for additional increases in interest rates. There are cracks in opinions on how quickly the Fed should continue to hike rates and whether it will soon be appropriate for a "pause" to assess the impacts of the tightening already in the pipeline.

Heading into the next scheduled policy meeting, on Nov. 1 and 2, communication is singularly ambiguous about whether FOMC participants expect to raise the target for the federal funds rate by 50 or 75 basis points at that time. We assume a rate hike of 50 basis points, which would put the upper end of the target range at 3¾%.

We expect additional rate increases in December and early next year will result in the upper target reaching 4¾%. With sustained progress on inflation, this could prove to be the "peak" funds rate for this phase. Both lower and higher trajectories are possible.

This week's US economic releases:

• Producer price index for final demand (Oct. 12): We estimate a 0.1% increase in September for the total PPI and a 0.5% increase in core PPI, which excludes the direct effects of changes in prices for food and energy.
• Consumer price index (Oct. 13): We estimate a 0.2% increase for the overall CPI and 0.4% increase for core CPI, which excludes the direct effects of changes in food and energy prices.
• Retail and food services sales (Oct. 14): We estimate a 0.2% increase in September. Excluding motor vehicle and parts dealers, sales declined 0.1%. Consumer spending habits are in the midst of shifting back toward pre-pandemic norms.
• Consumer sentiment level (Oct. 14): We estimate the University of Michigan Consumer Sentiment Index was unchanged from September at 58.6 in October. Retail gasoline prices, a key driver of sentiment, were roughly unchanged in most states over the past month, except in California, where prices have shot up.

Posted 10 October 2022 by Akshat Goel, Senior Economist, US Macro and Consumer Economics, S&P Global Market Intelligence and

Ben Herzon, US Economist, Insights and Analysis, S&P Global Market Intelligence and

Ken Matheny, Executive Director, Research Advisory Specialty Solutions, S&P Global Market Intelligence

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.