just now
February 20, 2023 - Growth likely to be weak as the impact of the Fed’s tightening, a deteriorating labour market, slowing wages growth and lower propensity to consume all combine to provide a material drag on activity. But a recession is by no means certain, and any period of negative growth will be less severe than that expected in the UK and Euro area.
- US growth this year looks set to be weak, at least in the first half. The monetary tightening delivered so far by the FOMC should translate into a weakening in consumption going forward, which, alongside an expected run-down in inventory levels, will weigh on economic activity. The Fed has already acknowledged that it is prepared to tolerate a period of negative growth if this is required to bring inflation back under control and therefore no official intervention to support growth, should such a downturn materialise, is expected. However, while the possibility of negative growth cannot be ruled out, it is likely to be shallower and less prolonged than the recessions expected in the UK and euro-zone.
- With the Fed willing to tolerate a period of below-trend growth in its pursuit of 2% CPI, the big uncertainty is whether consumers will continue running down excess savings to sustain current consumption levels, supporting economic activity in the process and working against the Fed, or choose instead to cut back on spending. Evidence to date suggests consumption is far from falling away, something the Fed will be keen to curtail as it seeks to remove demand from the economy.
- The heavy stock of savings built up during the Covid pandemic has so far provided a cushion that is protecting consumers from the impact of higher interest rates and tightening financial conditions (nearly 50% of these savings have now been spent). This is in turn providing a boost to economic activity. In addition to this, the fiscal transfers provided by the federal government, such as the Pay-check Protection Programme and payments made directly to households at the start of 2022, have provided a further spending boost. The combination of these factors has made the Fed’s task more difficult. But on the plus side they have probably been responsible for ensuring US growth has remained in positive territory to date.
- Going forward, how much more of this savings stock will be spent remains uncertain. Low-income households typically spend savings quickly and have likely exhausted their own funds already; better-off households typically spend them more slowly. A key issue here is that much of this dis-saving was a response to higher fuel prices seen over much of 2022 – people still needed to get to work, go food shopping etc. With fuel prices now lower this need to dis-save has passed. But it remains questionable as to whether households, in aggregate, will have the ability to maintain spending levels should fuel prices rise strongly again. So far fuel prices remain around 33% cheaper than the peaks seen last year. But the volatile situation in Ukraine and the re-opening of China makes the outlook for energy prices – and hence further dis-saving - uncertain.
- Further discouraging dis-saving are higher interest rates, which are increasing the opportunity cost of spending. Higher deposit rates may be sufficient to see households choose to cut back on expenditure in favour of maintaining savings at current levels, particularly when faced with the consequences of the Fed’s policy tightening (such as rising mortgage and loan costs).
- Tightening financial market conditions can also be expected to continue having a dampening effect on housing market activity, with home sales likely to remain under pressure. Home sales fell every month over the course of 2022 while prices rose steadily before stabilising in Q4. Key for 2023 will be if house prices start to fall too, the result of which may see consumers express increasing reluctance to fund discretionary spending. A slowdown in white goods sales is already likely following the fall in housing market activity last year.
- However, possibly the biggest challenge facing US consumers is the expected deterioration in the labour market. The re-hiring surge seen following the ending of covid lockdown measures and restrictions is waning and looks set to disappear altogether this year. Monthly payrolls data has been on a declining path since mid-2022 and the unexpected jump seen in January was likely an anomaly attributable to the unusually warm weather seen over the month. There are also signs that wages growth is finally starting to soften, although the Fed will want to see further progress made on this front before contemplating any easing in monetary conditions. Although wages growth slowed to 4.4% per year in January, this remains incompatible with a 2% CPI target.
- At the same time, evidence of companies looking to make cost savings is being seen, most notably so far in the technology sector, where substantial layoffs have been announced/made. This is a trend that can be expected to spread to other sectors going forward: survey data has been highlighting an increasingly uncertain outlook which can be expected to translate into a reduced demand for labour. Indeed, the softening final demand readings seen over H2 2022 suggests the resilience seen in the payrolls numbers to date will not be sustained.
- Retail sales have been slowing over the course of 2022 and, ignoring the surge in spending seen in January’s print – which again is likely to be weather related – the outlook for 2023 looks set to be a continuation of this trend as the Fed continues to tighten policy. Fears over job losses also typically sees spending curtailed in favour of saving, providing a further drag on consumption.
- Peak inflation finally appears to have passed with headline annual CPI now have fallen every month since June. A significant factor behind this fall has been the general easing being seen in supply-chain restrictions which has boosted supply and brought down the price of final products as margins have been compressed. In addition to this, and as noted above, expected weaker consumption in the face of a softer labour market, coupled with a lower propensity to reduce savings, will provide an additional deflationary effect. How quickly inflation falls will be a significant factor in determining the Fed’s stance going forward, although how fast the labour market softens will be an important factor here too.
- Market expectations are for further 25bps rate hikes to be delivered at the March and May FOMC meetings, with a rough 50/50 chance seen of a further 25bps hike also being delivered in June. Rates are seen peaking at 5.25% before falling to around 5.0% by year end. The Fed similarly is forecasting rates to rise to 5.25%, although has frequently signalled that a higher terminal rate remains a possibility, possibly reaching as high as 5.75%. However, even if the Fed’s highest forecast comes to fruition, this still represents only 1% of further tightening in 2023 compared to the 4.25% seen in 2022. But it will remain unwilling to signal any shift in its hawkish stance until it sees concrete evidence of a softening in the labour market, essentially an easing in wages growth.
