Are We Done Talking About A Recession?
The Look Ahead
Because of higher prices and interest rates over the past two years, it’s easy to focus on what’s wrong with the economy. However, diminished inflation amid declining oil, gasoline and goods prices, it is time to focus on what is driving overall economic activity. The U.S. economy has proved far more resilient and less sensitive to interest rate hikes than it has in past business cycles.
Inflation is declining rapidly amid robust hiring and an unemployment rate that stands at 3.6% despite a steep rise in interest rates. The rapid decline in inflation from 9.1% a year ago to 3% in June, enables the U.S. economy to resist recession.
Monetary policy has been restrictive for several months now. Downward inflation should give the Federal Reserve some breathing room to hold rates steady. This may keep private sector interest rates from moving significantly higher.
Falling energy prices over the past few months have helped to reduce headline inflation, while core inflation metrics, which exclude volatile energy and food prices, have seen less progress especially in services categories. Core goods inflation has dropped from 12% to 2% over the past year, while core services inflation has only slowed to 6.6% in June from its peak of 7.3% in February. Expect gradual improvement in inflation over the coming months, though a return to the Fed’s targeted 2% level could take until late 2024.
Recession Avoided, So Far
Measured by real GDP, the U.S. economy has expanded at an estimated 1.5% to 2.0% annualized pace in the first half of this year.
If consumer spending moderates as expected in the second half of this year, the U.S. could enter a slow down by December. Some economists predict real GDP to decline by 0% to 1% for the fourth quarter of 2023 and the first quarter of 2024. Whether the slower pace of growth is enough for the National Bureau of Economic Research to call it a recession is anyone’s guess.
Labor Remains Tight
Inflation may finish the year near 2.8% as households will most likely experience further increases in real wage gains that support overall spending and economic activity. Labor demand has proved far more durable than expected with a low 3.6% unemployment rate, the labor market remains historically tight. However, mounting pressure on corporate profit margins could cause employers to slow hiring or reduce headcount in the months ahead. Expect the unemployment rate to rise to the 4-4.5% range by December and 5% by the end of 2024.
Excess savings from the pandemic days continues to shrink, so expect that spent by year’s end. While spending through the first half of the year has been resilient overall, growth is moderate. There’s an ongoing shift towards services like travel, dining out and live entertainment. The restart of student loan payments later this summer may take a little wind out of the sails. However, household balance sheets still appear to be on solid footing, with most borrowings locked in at low fixed rates. Delinquency metrics for credit card debt and auto loans have normalized, but don’t look particularly weak compared to prior cycles.
Manufacturing: Improved Supply Chain
While some inflationary pressures remain high, shipping costs have dropped to pre-pandemic levels as supply and demand dynamics normalize. Pressures on the supply chain side have diminished with lower shipping costs, greater container ship capacity and shorter delivery times. Availability of semiconductor chips and components have not fully recovered to pre-pandemic levels but are continuously improving.
Given the upheaval in the past three years, companies are reviewing and implementing changes to their supply chain strategy. The second half of 2023 should bring more announcements of long-term supply chain choices. Upgrading inventory management and multi-sourcing strategies is a long game requiring time and further investment. Reshoring can take years to implement.
Manufacturing wage growth is still historically high, but indicators point towards the worst being over. Expect inflationary wage pressures to decline as the economy slows and labor markets soften further.
Housing Begins To Stabilize
Housing finds its footing in recent months after a 30-40% drop in activity through the second half of 2022. With 30-year fixed mortgage rates holding at 6.5-7.0% since last November, housing starts, existing home sales and home builder sentiment have begun to stabilize. Median home values remain elevated and within 5% of all-time highs supported by historically low vacancy rates.
Traditional Bank Lending Remains Tight
Small and regional banks reduced lending in the first quarter of 2023. Slower loan growth from regional banks could stymie economic activity for small business owners seeking capital. Uncertainties remain elevated concerning the lending growth outlook.
Construction Spending Increases
According to the U.S. Census Bureau, Construction spending is on the rise.
June 2023: $1,938.4 billion
May 2023: 1,929.6 billion
Statistics released August 1, 2023.
Construction spending during June 2023 was estimated at a seasonally adjusted annual rate (SAAR) of $1,938.4 billion, 0.5% above the revised May estimate of $1,929.6 billion. June’s figure is 3.5% above the June 2022 estimate of $1,873.2 billion. During the first six months of this year, construction spending amounted to $917.4 billion, 3.0% above the $890.4 billion for the same period in 2022.
Spending on private construction was at a (SAAR) of $1,516.9 billion, 0.5% above the revised May estimate of $1,509.4 billion. Residential construction was at a seasonally adjusted annual rate of $856.3 billion in June, 0.9% above the revised May estimate of $848.6 billion. Nonresidential construction was at a seasonally adjusted annual rate of $660.6 billion in June, virtually unchanged from the revised May estimate of $660.8 billion.
In June, the estimated (SAAR) of public construction spending was $421.4 billion, 0.3% above the revised May estimate of $420.2 billion. Educational construction was at a seasonally adjusted annual rate of $88.9 billion, 0.1% below the revised May estimate of $89.0 billion. Highway construction was at a seasonally adjusted annual rate of $128.6 billion.
These conditions imply that the probability of a soft landing is possible, barring any domestic catastrophe or additional global conflict. The U.S. economy may continue to wade through soft growth as it adjusts to elevated inflation and higher interest rates. Robust labor demand, solid consumer spending, modest residential construction and a nascent manufacturing renaissance will all prove to be tailwinds for the economy.
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