H2 2023 outlook for the United States

By Stuart Cole | @Stuart Cole | 24 August 2023

In summary, we continue to see growth weakening over H2 as the impact of the Fed’s monetary tightening starts to be fully felt. In addition, the fallout from the banking crisis is seeing bank lending to both corporates and consumers become more expensive and difficult to access as banks focus on building up liquidity rather than expanding lending. This will act as an additional drag on growth alongside the Fed’s actions.

On top of both of these things, the continued normalisation of the labour market will see wages growth slow alongside an increase in job insecurity. These factors will act to suppress consumer demand. How deep this contraction will be, and by implication the additional headwind to growth it represents, will to a large degree depend on the continued willingness of US households to deplete the excess savings stocks built up during the covid pandemic. However, the bulk of these savings have already been spent meaning the potential boost available to consumption is much less than it has been to date. Furthermore, we expect to see a shift away from further dis-saving going forward, both as a precaution against a more uncertain labour market and as the opportunity cost of not saving rises.

US growth this year still looks set to remain below trend. But it has held up more strongly than expected and as such our baseline scenario is that the economy will avoid tipping into recession in the current cycle. But this is not to say the risk of a decline in GDP has disappeared entirely. With the Fed still apparently willing to contemplate further interest rates rises, and the monetary tightening delivered so far yet to be fully felt, economic activity will continue to face significant headwinds going forward. And the boost to consumption that was provided from the run-down in excess savings appears to now be largely exhausted. The Fed has acknowledged that it would prefer to over-tighten rather than under-tighten policy to ensure CPI moves sustainably back to target, and with survey data indicating lower holdings of inventories and reduced capital expenditure going forward, so we do not expect growth to return to its long-term trend until at least 2025.
The fallout from the banking sector crisis continues to be felt, with the corporate sector - and particularly bank-dependent small businesses - showing growing signs of funding distress as the cumulative impact of the Fed’s monetary tightening increasingly bites. The Fed has so far raised rates by 525bps; over the past five decades rate hikes of more than 300bps have been enough to stall the economy. Although the March banking crisis saw bank lending standards materially tighten, in practice these had been tightening some time before the SVB and Signature Bank failures, and as banking lending to companies falls so the squeeze on working capital and asset finance this represents is hampering the ability of firms to maintain both employment and inventory levels. It is this drag on corporate activity that will be the main driver of below trend US growth going forward.
The biggest challenge facing US consumers will be a deterioration in the labour market, signs of which are now increasingly starting to be seen. The post-covid boom in catch-up recruitment finally appears to be over and the downwards pressure on economic activity being exerted by the Fed is increasingly the dominant force at play. Wages growth still remains too high for the Fed’s liking, but this will slow as falling demand for labour begins to dominate. Lower headline inflation will of course boost real incomes, but reduced hiring plans and the pick-up being seen in layoffs signal a slower jobs market ahead. The BLS August revision to the nonfarm payrolls numbers has already shown the underlying strength of the labour market to be softer than thought. However, the Fed will still wish to see further progress being made on the wages front before it will be comfortable with any easing in monetary conditions.
Retail sales slowed considerably over the course of 2022 and, ignoring the weather-related boost to consumer activity seen in January and February this year, was a trend that continued over H1 2023. However, consumer spending appears to have made a strong start to Q3, raising the question of whether spending growth is now re-accelerating. Our base assumption is that consumer activity will remain subdued for at least the remainder of this year and that much of the jump seen in July’s sales numbers will be partially reversed going forward. As wages growth starts to return to trend so falling household incomes will see spending patterns naturally reined in, while increasing job insecurity as the labour market normalises will see spending curtailed in favour of saving, providing a further drag on consumption. The resumption of student loan repayments from October will provide a further impediment to spending.
Peak inflation appears to have now passed, with all the various measures of pricing pressures now aligning in the same direction and pointing to inflationary pressures finally receding. The pace of this fall is expected to accelerate over H2 as the previous main upwards drivers of CPI, namely food and energy prices, expanded margins, high rents, strong wages growth and disrupted supply chains, all start to normalise. A similar story is also being displayed by the PPI figures, which are suggesting even more repaid declines in both goods and services inflation. Accordingly, our expectation is that CPI will fall faster than the Fed is currently anticipating and that further interest rate rises are not required. So far the FOMC has not had to address slowing CPI and a weakening labour market simultaneously, providing the 'hawks' on the Committee with the arguments needed to keep the hawkish stance in place. Going forward this dominant hawkish position is set to weaken, paving the way to a more growth-supportive stance.
The Fed has kept open the possibility to raise interest rates further going forward and the possibility of a further interest rate rise being delivered remains a real possibility. A majority on the FOMC clearly still feel – publicly at least – that inflation will not return to target without further hikes and as such a further interest rate rise at September’s FOMC meeting cannot be ruled out. However, the need for further monetary tightening is unnecessary and by the time of September’s meeting the data should clearly be signalling this. Accordingly, even if a further 25bps rise is delivered, it will be the final increase of this cycle. The pivot towards easing is likely to take longer, given the FOMC’s fear of getting the inflation argument so wrong again. But it makes no sense to see real rates rising as the labour market softens and inflation falls. Accordingly, we expect interest rates to start being cut from end-Q1.
The housing market still has further to fall, with total sales looking set to decline further as the higher cost of mortgages continues to erode demand for home loans. Admittedly new home sales have been rising, but this reflects a lack of availability of existing housing stock as homeowners baulk at the increased cost of moving and re-mortgaging onto substantially higher priced products. Some 60% of current mortgages carry a fixed rate of 4% or less, compared to the near 7% cost of new mortgages. Until affordability improves, which will require lower interest rates, both overall demand and supply for housing will remain below trend.