In the third quarter of 2021, inventory rebuilding accounted for 99% of the 2.3% annualized increase in real gross domestic product and 78% of the 6.9% increase in the fourth quarter. Much of the inventory was held in anticipation of robust consumer spending should households accumulate their excess savings. But they didn’t. So, the depletion of excess inventories this year will weigh on economic growth. The chronic and rising international trade deficit is also weighing on the US economy, while small business optimism wanes.
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The rise in mortgage rates from 3.22% at the start of the year to 4.67% most recently, the absence of further pandemic-related government payments to households and the completion of the city housing rush to suburban and rural housing should empty the single-family housing bubble. Existing home sales in February were down 7.2% from January and 2.4% from a year earlier. The impact of housing weakness roughly doubles when furniture, brokerage commissions, moving expenses, and other related expenses are included. Meanwhile, inventories of new homes for sale are at their highest since mid-2008 and will continue to rise even as demand eases. The National Association of Home Builders market index rose from 10 in 2008 to 79 in March, with 50 being the dividing line between growth and contraction.
Meanwhile, the Federal Reserve has launched a campaign to tighten monetary policy by raising interest rates in response to increased inflation. Such reversals often lead to recessions, which is even more likely now that the central bank is transitioning from injecting $140 billion a month into the financial system through purchases of Treasuries and mortgage-backed securities to investing its cumulative $8.9 trillion to shrink the portfolio.
The inversion of the Treasury market’s yield curve, with 2-year yields higher than 10-year yields, is another ominous sign given the history of previous recessions. So was the fall in share prices in the first quarter, with the Dow Jones Industrial Average down 4.6%, the S&P 500 Index down 4.9%, and the Nasdaq Composite Index down 9.1% from where the year began. In the post-WWII era, bear markets have consistently led or coincided with peaks in business activity.
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Of course, the global political, economic and financial disruptions triggered by Russia’s invasion of Ukraine are adding recessionary pressures.
So the US economic outlook is in the hands of households and their purchasing power is falling. Average hourly wages rose 5.6% in March from a year earlier, the Labor Department said on Friday, but impressive as that is, they’re still below the 7.9% rise in the CPI. And households are reluctant to spend their accumulated savings, with the University of Michigan sentiment survey revealing a 30% drop in confidence over the past year.
Furthermore, there is no evidence that households expect inflation to remain high for years to come and will therefore rush to buy goods now before prices rise even further, as they did in the late 1960s and 1960s was the case in the 1970s. Such excess demand strains inventories and capacity, causing prices to rise, confirming inflation expectations and creating a self-feeding spiral. Today, however, New York Fed surveys show that consumers expect annual inflation to be 3.8% over the next three years.
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In addition, the purchasing power of households is being dampened by the pandemic-related loss of work. Labor force participation rates of 68.3% for men and 56.6% for women remain below pre-pandemic levels of 69.3% and 57.9%. Additionally, according to the Dallas Fed, 1.5 million more workers have retired earlier than implied by previous trends.
Instead of spending their savings, Americans continue to deleverage as a proportion of their after-tax income. Home appreciation and stock portfolio appreciation since the pandemic began are also potential sources of funding to boost spending. But the overwhelming owners of these asset classes are high-income households that have already met their spending wants and needs and are not very sensitive to asset price fluctuations.
After-tax household income jumped with each of the three rounds of stimulus, but consumer spending fell after the first round in 2020 and barely bounced by the second and third payments in 2021, but has risen by $1.7 trillion consumer spending is up a little more, or $1.9 trillion.
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With real incomes falling and US consumers reluctant to spend their accumulated savings from pandemic-related stimulus, let alone spending on current income, economic growth will be minimal this year. And it can be negative as a previous inventory accumulation is reversed.
More from authors at Bloomberg Opinion:
• The Fed has made a US recession inevitable: Bill Dudley
• Job report gives Fed green light to go all out: Jonathan Levin
• Yield curves are often right for the wrong reasons: Robert Burgess
This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Gary Shilling is President of A. Gary Shilling & Co., a New Jersey consulting firm, a Registered Investment Adviser, and author of The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation. Some of the portfolios he manages invest in currencies and commodities.
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