By Jeffry Bartash
Recession worries are easing – for now – as inflation slows and the economy strengthens
Due to rising interest rates, the US should now be in or near a recession. Instead, a resilient economy is aiming for a tripling, that is, a 2% growth in gross domestic product, the official measure of the economy, for the third straight quarter
Nearly halfway through the third quarter, GDP is on track to see the US economy grow 2.4% to 4.1% annually, according to two of the most followed forecasts.
The Atlanta Federal Reserves Nowcast puts growth at 4.1%. S&P Global, arguably the gold standard on Wall Street, estimates economic growth at 2.4%.
By the end of the quarter on Sept. 30, the estimate should get closer to 2 percent, but even then it would be a remarkable achievement. Higher borrowing costs historically weaken the economy, often leading to a recession within a year or two.
For nearly a year and a half, the Federal Reserve has hiked a key short-term US interest rate from near zero to a peak of 5.5% in a bid to contain inflation.
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Still, the economy grew at a solid annual pace of 2% in the first quarter and even faster at 2.4% in the second quarter. The surprise rate of US growth this year is slightly above what analysts see as the highest sustained speed for the economy.
It shouldn’t have happened. Senior Fed officials predicted the economy would slow in 2023, while economists put the chance of a recession at 50% or more.
Of course, the economy did not get off scot-free. Rising interest rates have depressed the housing market, weakened manufacturing, constrained business investment and forced banks to scale back lending.
But the foundation of the economy – consumer spending – has remained stable.
Americans buy relatively fewer goods, such as home appliances, but spend more on services such as travel, leisure, and dining out.
Some economists speak of a post-pandemic squandering of spending categories that were relatively off-limits during the spread of the coronavirus. However, the biggest increase is likely to be due to a dynamic labor market.
See: Would you like companies to lower their prices? Show them you mean business
Most Americans looking for a job are able to find one, keeping the unemployment rate near a half-century low of 3.6%. Businesses are still hiring despite worries about a potential recession, and are reluctant to lay off workers after recently experiencing the worst labor shortages in modern times.
Just look at initial jobless claims, an indicator of layoffs. They fell sharply over the past month, returning near post-pandemic lows after a surge earlier in the summer.
“With initial and standing jobless claims also declining, the economy appears to be stabilizing after a shaky patch that began in mid-2022,” said Bill Adams, Comerica’s chief economist.
In turn, the tight labor market has pushed wages up at the fastest pace in years – not enough to fully offset a rise in prices due to high inflation, but enough to limit the damage.
The result: consumers are confident enough to continue spending — and to keep the economy in expansionary mode. In addition, consumer confidence surveys have improved significantly in recent months after falling to new lows earlier in the year.
Confidence, both large and small, has also partially recovered from recent lows, on the back of resilient consumer demand and strong earnings.
See: Consumers see significant improvement in US economy over the past three months: University of Michigan survey
“Corporate earnings reports to date suggest that companies continue to hold up reasonably well,” said Stephen Stanley, chief economist at Santander Capital Markets.
There are other tailwinds too.
Government spending is well above pre-pandemic levels, including green energy-related subsidies for manufacturers and higher Social Security benefits due to inflation.
Even with bonds, savings accounts and the like, savers finally get a decent return.
See: Social Security’s COLA could be about 3% in 2024 – after an 8.7% increase in 2023
Can the economy maintain momentum in the final months of 2023? That will depend on whether labor cost increases are moderated and inflation continues to decelerate towards the Fed’s 2% target. Inflation is now between 3% and 4.8%, depending on the unit of measurement.
Easing price pressures would allow the Fed to end its current cycle of rate hikes and breathe life into the economy, while higher rates would do the opposite.
Some economists and Fed officials even believe such a scenario could result in a fabled soft landing, with the Fed beating inflation without triggering a recession. That has only happened once or twice since World War II.
“There is still a plausible story that inflation will normalize in a short period of time and the economy will avoid further trauma,” said Thomas Barkin, president of the Richmond Fed.
That’s not what the centrist Barkin might have expected a year earlier, when in another speech he pointed out that eight of the Fed’s previous tightening cycles had ended in recession.
-Jeffry Bartash
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(ENDS) Dow Jones Newswires
08/13/23 1135ET
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