ECONOMIC REVIEW January 2024

The Recession That Hasn’t Happened:

In 2023, the U.S. economy appeared to be headed toward a recession. Contrary to these expectations, the economy demonstrated solid growth, surpassing 2022 growth rates. A key driver of this growth has been consumer spending, which constitutes approximately two-thirds of U.S. GDP. This spending surge is partly attributed to a 37% increase in consumer net worth from 2019 to 2022, as shown below, to over $150 trillion.

Another hypothesis for the increase in consumer spending relates to current trends in the housing market. Elevated home prices and higher mortgage costs have made home buying increasingly inaccessible to many young people. This has possibly influenced a shift in spending patterns, driving an even higher preference for travel and other experiential purchases over saving for a home down payment.

A more moderate growth trajectory is expected for 2024. Economists forecast 1.2% real GDP growth (adjusted for inflation) and 3.9% nominal GDP growth (including inflation), compared to an estimated 2023 real growth of 2.4% and nominal growth of 6.5%. While corporate earnings have shown an upward trend, the anticipated 11% consensus earnings growth in 2024, alongside 5% revenue growth, may be overly optimistic.

Higher Interest Rates Have Not Had A Big Impact (Yet):

Despite rising interest rates, households have been relatively shielded from significant impacts, largely because only about 10% of household debt is subject to adjustable rates, maintaining a relatively low debt service burden.

Businesses have also been insulated from the effects of higher interest rates. Corporations have shown a significant decrease in interest expense as a percentage of cash flow, primarily due to debt refinancing at lower rates in prior years.

In some ways, higher interest rates have helped the economy, since the presence of nearly $6 trillion in money market funds, yielding approximately 5% interest, acts as a $300 billion economic stimulus for both consumers and businesses.

Inflation Has Moderated:

As indicated by the Consumer Price Index (CPI), inflation reached its peak in June 2022 at 9.1%, declining to 3.1% in November 2023. The Core CPI, which excludes the more volatile food and energy sectors, peaked at 6.6% in September 2022 and has moderated to 4.0%. Consumer inflation expectations have also decreased over the past 18 months, as shown below.

Although inflation rates are above the Federal Reserve’s targets, shelter inflation, a major component of the CPI, has peaked and is expected to continue its downward trend, due partly to lagged data for shelter costs. Rent inflation has already moderated from 16% to 3%.

Possibly contributing to inflation’s moderation, labor productivity growth has increased to its highest level in nearly 15 years (excluding a blip at the beginning of COVID), reaching 5.2% in the third quarter of 2023.

Rolling Recessions:

The U.S. economy may have avoided a broad economic recession through “rolling recessions,” a phenomenon in which recessionary conditions move from one industry to another rather than impacting all sectors simultaneously. Key economic segments like housing, manufacturing, and consumer-oriented industries have experienced recession-like conditions at different times over the past three years.

Not Out of the Woods:

While the path to avoiding recession is becoming clearer, we are not out of the woods yet and caution is warranted. Many leading economic indicators continue to point toward recession. A yield curve inversion typically precedes a recession by one to two years. Current data suggests we are at the average lag period before a recession’s onset, or about 14 months.

Unemployment, often the last indicator to weaken before a recession, has shown a slight increase but remains at historically low levels. Given the strength in consumer spending, the trajectory of the unemployment rate will be crucial in determining whether the U.S. economy faces a full-scale recession in 2024.

The Path Ahead:

Although the Federal Reserve's recent interest rate increases have not significantly impacted the economy, prolonged high rates could lead to more substantial effects, particularly as businesses confront refinancing maturing debts initially acquired at much lower interest rates. Our concern has been the Federal Reserve's tendency to avoid reducing rates until it becomes critical. However, in a mid-December statement, Federal Reserve Chair Jay Powell noted the slowdown in inflation and mentioned that the Fed is contemplating rate cuts, potentially starting as early as mid-2024. The Federal Open Market Committee anticipates three rate cuts in 2024, in contrast to market expectations of seven, beginning in March, as illustrated in the data below. The Federal Reserve could play a significant role in steering the economy away from an economic downturn by taking a more proactive approach to rate cuts than it has historically.