Fourth quarter outlook: hawkish central banks versus resilient private economy

Fourth quarter outlook: hawkish central banks versus resilient private economy

Time to read: Minutes
Douglas Cote

Douglas Coté, CFA

Head of Global Perspectives Strategies

Executive Summary

  • Central banks have been trying to stoke inflation for two decades — “Be careful what you wish for.”
  • Supply-side economics needs to be added to the policy toolkit to solve rampant inflation, especially in taming surging energy costs.
  • The firehose of bad news on the front page hides the strong fundamentals on the back page.
  • Extreme market volatility will test financial plans; we believe those that stick to the fundamentals will fare the best.

Fighting inflation takes a complete set of policy tools

There is much ado about the need for the Federal Reserve to beat inflation with its “quantitative tightening” (QT) hammer — the only tool it has — by engaging in “demand destruction,” that is, to slam the brakes on spending. Well, let me bring some economics into the solution. As you would learn in any Economics 101 course, there are always two ways to reduce prices. The first way is the “demand-side,” which is how Fed policy works: curtailing prices by crimping spending. The second way is the “supply-side.” Supply-side economics focuses on increasing incentives — usually in the forms of easing regulations and lowering taxes — to persuade businesses to make, supply or produce more goods than demanded, causing prices to fall.

The Fed has the tools for the demand-side, whereas Congress has the tools for the supply-side. The inflation problem can be solved with economics by reducing demand and increasing supply. To use just one side of economics is not only dangerous but also may be ineffective.

Absent supply-side fiscal policy from central banks, expect further aggressive rate hikes to combat continued elevated inflation rates. The September 2022 US payrolls report raised alarm bells of a resilient economy as the unemployment rate improved, dropping to 3.5%. Multiple ongoing crises in Europe have led to a debilitating energy crunch and tightening financial conditions, which are likely to send it into a severe recession. We expect 75–125 basis point (bp) rate boosts from the Fed, European Central Bank (ECB) and the Bank of England (BOE) by year-end, which certainly will not be stock market friendly.

So why do economic and corporate earnings fundamentals continue to be resilient? Well, the private economy “marches to its own drummer” and adapts to any adverse macroeconomic backdrop. At present, the performance of the US labor market and S&P 500 earnings growth seem to be defying gravity, and this is good news in a sea of trouble. It is exactly this resiliency that makes a case for ceasing with the Fed hammer and promoting the private economy via supply-side policies. Let’s review the private economy’s health.

Advancing corporate earnings and US economic growth

The most recently reported actual quarterly results for the S&P 500 were for the second quarter of 2022. The index gain was 8.4% (see Figure 1), with topline revenue growth of 13.6%, which was led by the energy sector at 295.5% growth.

Let’s review economic growth, another key fundamental. Gross domestic product (GDP) declined by 1.6% in 2Q22, with bigger than expected downward revisions for intellectual property investment and exports. Consumption grew 2%, the durables component fell by 2.8% while services continued their run, gaining 4.6%. Business fixed investment declined 5.0% after increasing 4.8% in 1Q22. Residential construction plummeted by 17.8% on rising mortgage rates.

Two quarters of negative GDP growth is a technical recession, compounded by still high inflation numbers from the GDP report. The chain price index was revised up to 9.0% from 8.9% and is the hottest since 1981. The core rate rose to 4.7% from 4.4% and is the highest since 1983.

We do not have actual 3Q22 GDP yet, but we do have the Atlanta Fed’s GDPNow forecast. The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2022 was 2.9% as of October 7. This certainly is good news but calls into question whether the Fed’s draconian response is worth the pain it’s inflicting on the markets; or whether the pain might be the point.

Figure 1. Fundamentals drive markets with good 2Q22 earnings per share (EPS) growth

Source: Refinitiv – Thomson Reuters and FactSet, Voya Investment Management. Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. The S&P 500 index is a gauge of the US stock market that includes 500 leading companies in major industries of the US economy. Past performance is no guarantee of future results. Indices are unmanaged and not available for direct investment.

Broadening manufacturing

The US ISM Manufacturing Index dropped from 52.8 to 50.9, indicating expansion for the 28th month on contracting new orders and employment while shipments grew. Good news on inflation, the subcomponent to the report on manufacturers prices paid dropped to 51.7 from 78.5 in June.

The strong US dollar and its rising value relative to the euro, yen and pound make our exports more expensive and imports cheaper, further hurting US sales. This is compounded by the exports being paid for in foreign currencies that exchange into fewer US dollars, further reducing the bottom lines of US companies.

Usually, a strong dollar would benefit these foreign countries by increasing their competitiveness on price; but the Federal Reserve’s lightning-speed rate increases have wreaked havoc on their currencies, especially in Britain. Of course, former Prime Minister Liz Truss compounded Britain’s problems by announcing policies that spooked markets further.


S&P Global Eurozone manufacturing PMI was revised down to 48.4 for the final reading in September, squarely in contraction territory. As highlighted in the report, “…in some cases, production volumes were reduced in response to high energy prices… demand for European goods sinking sharply…”

In other news, Eurozone harmonized inflation consumer prices (HICP) inflation hit 10.0% year over year, putting further pressure on the BOE and ECB to hike rates and to engage in QT to reduce their balance sheets in the face of weakening currencies. The UK is in the cross-hairs of a financial meltdown that required an emergency bailout of pension funds, though it may be too late due to their overexposure to collateralized loan obligations (CLOs).

China lockdowns and slowing growth

The lockdowns in Shanghai and other cities throughout China continue despite our “hope” that they would temper by the start of the Communist Party Congress that elected Xi Jinping to a third five-year term as party leader. Meanwhile, headline readings from the Caixin manufacturing and services reports contracted for September at 48.1 and 49.3, respectively. These decreases have important ramifications for the global economy, as China is the second largest economy in the world.

Housing market

This isn’t 2008, when speculation was rampant and the biggest speculators were people who had no net wealth. For many years, banks have enforced strict lending standards: buyers must be adequately capitalized and able to put at least 20% down for home purchases. There almost certainly is speculation in the housing market, and the speculators likely will face detrimental financial consequences, but the damage is not likely to spread to the banks. Higher housing costs may prompt consumers to curtail other spending. Those companies that depend on consumer spending will feel pain as their profits diminish — but again, this isn’t 2008.

Consumers as gamechangers

The consumer certainly is the gamechanger, like, always. Now the question is, Will consumer spending have a negative or positive impact? US retail and food services sales for August 2022 were $683.4 billion or 9.1% above August 2021 (Figure 2).

Figure 2. US retail sales continue to set records

Source: FactSet, US retail sales as of 08/31/2021.

Market review third quarter 2022

On Friday, September 30, the major US indexes closed in the red, posting losses for the week, month, quarter and year to date. The S&P 500 index booked a new year to date low as investors fretted about inflation, geopolitical risk and global economic growth. The Fed’s continuation of rate hikes to fight rising inflation, economic growth and geopolitical risk concerns, and a soaring US dollar combined to drive losses across asset classes in 3Q22.

The S&P 500’s 9.2% decline in September brought the index’s total return for the first three quarters of the year to a dismal -23.9%. The mid cap S&P 400 index and small cap S&P 600 index stocks fell 2.5% and 5.2% respectively in the quarter. Stocks also fell in Asia and Europe. US Treasury yields rose as the Fed reiterated it won’t end rate hikes prematurely. The ten-year note climbed to 3.80%, the two-year to 4.20%; the two-to-ten spread narrowed to –40 basis points. The Bloomberg US Aggregate Bond index returned -4.8% for the quarter, as high yield bonds sported a 9% yield. The Bank of England intervened to support the pound, buying UK sovereign bonds in an effort to halt a market rout triggered by the British government’s aggressive tax-cutting plans.

The CBOE volatility index closed at 31.6%. The S&P GCSI commodity index was down 10.3% for the quarter, but up 21.8%. for the year.

Figure 3. Third quarter market performance prolonged the year to date downturn

Source: FactSet, data as of September 30, 2022.

* Simple averages of all the indexes included in each group: all equity indexes, all fixed income indexes and a combination of all equity and all fixed income indexes. Please see disclosures at the end of this commentary for index definitions. Past performance is no guarantee of future results. Investors cannot invest directly in an index.


It is simply astounding, the relentless pace at which fixed income yields continue to rise. First, it was the two-year US Treasury note that smashed through a 4% yield; since then, the 10-year note has hit a 4-handle and 30-year mortgage rates are being quoted at over 7%. The repercussions are severe because interest rates are a discounting mechanism for financial assets, and higher rates potentially lower the prices and values of securities such as stocks and bonds. High interest rates that discount financial assets are not about investor bias, they are purely math.

Where do we go from here? The outlook for the fourth quarter and beyond is that the global central banks led by the Federal Reserve may or may not be successful in curbing inflation, but the devastation that they are inflicting on investors is likely to continue. This approach already is creating unintended consequences, with countries and continents at risk of financial meltdowns. The fundamentals are what I always come back to, though, and they have been relentlessly positive. Fundamentals are my north star, and they are signaling to “stick to the plan


General investment risks: all investing involves risks of fluctuating prices and the uncertainties of rates of return and yield inherent in investing. All security transactions involve substantial risk of loss. Diversification does not guarantee a profit or ensure against loss. The S&P 500 index is a gauge of the US stock market, which includes 500 leading companies in major industries of the US economy. The S&P MidCap 400 Index is a benchmark for mid-sized companies, which covers over 7% of the US equity market and reflects the risk and return characteristics of the broad mid-cap universe. The S&P SmallCap 600 index covers approximately 3% of the domestic equities market and is designed to represent a portfolio of small companies that are investable and financially viable. The FTSE EPRA/NAREIT Global Real Estate index is designed to represent general trends in eligible real estate equities worldwide. The MSCI EAFE index is a free float-adjusted market capitalization weighted index designed to measure the developed markets’ equity performance, excluding the US and Canada, for 21 countries. The MSCI Emerging Markets index is a free float-adjusted market capitalization index that measures emerging market equity performance of 23 countries. The Bloomberg US Corporate Bond index is a component of the Bloomberg US Aggregate index. The Bloomberg US Aggregate index is composed of US securities in Treasury, government-related, corporate and securitized sectors that are of investment-grade quality or better, have at least one year to maturity and have an outstanding par value of at least $250 million. The Bloomberg US Treasury 20+ Year index tracks the performance of US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with 20 or more years to maturity. The Bloomberg Global Aggregate Bond index measures a wide spectrum of global government, government related, agencies, corporate and securitized fixed-income investments, all with maturities greater than one year. The Bloomberg US Corporate High-Yield Bond index tracks the performance of non-investment grade US dollar-denominated, fixed rate, taxable corporate bonds including those for which the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below, and excluding emerging markets debt. The S&P 500 Value index tracks the performance of the subset of S&P 500 stocks classified as value style, as measured by three factors: the ratios of book value, earnings and sales to price. The S&P 500 Growth index tracks the performance of the subset of S&P 500 stocks classified as growth style, as measured by three factors: sales growth, the ratio of earnings change to price and momentum. The CBOE Volatility index (VIX) is a real-time index that represents expectations for the relative strength of near-term price changes of the S&P 500 index. The S&P GCSI index is a benchmark commodities index that tracks the performance of the global commodities market. It is made up of 24 exchange-traded futures contracts that cover physical commodities spanning five sectors.

Important information

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