Updated outlook for US economy: banking crisis and tightening credit conditions point to negative growth

Our outlook for the US economy has worsened since we published our H1 2023 forecast in January, this deterioration predicated largely on the negative consequences we expect to see from the banking crisis that emerged in March. The failures of Silicon Valley Bank, Signature Bank etc., are expected to see a significant curtailment in the aggregate volume of credit made available to both the corporate sector and consumers going forward, as banks are forced to focus on ensuring that sufficient liquidity is held on balance sheets to meet any potential further deposit runs that might be faced, rather than lending. This hoarding of liquidity – essentially maintaining stocks of readily available cash - will be achieved via a combination of additional access being made to the borrowing facilities provided by the Federal Reserve alongside a curtailment in lending, the latter being achieved by a material tightening in lending standards and increase in the cost of credit corporates/consumers will have to face going forward.

Lending standards were already tightening following the 500bps of interest rate hikes delivered by the FOMC over the past 15 months, the fastest pace of tightening since 1980, and which was already seeing a material downturn in corporate sentiment and activity. Lending standards, capital expenditure plans, hiring intentions and inventory levels are fast approaching the levels seen at the time of the Global Financial Crisis in 2008, a period that saw 5 quarters of negative growth, including a drop in output of -8.5% in Q4 2008. While we are not suggesting a scenario as bleak as that, a shorter period of negative US growth appears inevitable now.

At the same time, the previous drivers of inflationary pressures in the US appear to be finally weakening. Global food and oil prices are now retreating, average earnings are heading back towards their pre-covid levels, rental prices are virtually back to their pre-covid norms, and the huge expansion seen in wholesale and retail margins as global supply chains snarled up are now close to reversing as production lines return to normal. While the move lower in these pricing pressures is a bumpy ride rather than a smooth one - the recent increases in the Employment Cost Index and the PCE Deflator number are cases in point - the underlying direction of travel is downwards in all cases.

Lastly, there will be no demand panacea delivered from the global economy that is able to take up any slack, with the growth outlook in both China and Europe similarly looking increasingly fragile.

The combination of these things, ie negative growth, lower inflation and the drag from the external sector, we believe will see the Federal Reserve perform a U-turn in policy as it is forced to turn away from suppressing rising prices and instead focus on supporting growth once more. We expect the May FOMC meeting to have delivered the final rate hike in this cycle and envisage some 50-75bp of interest rate cuts being quickly delivered over Q4/Q1, before a more gradual pace of monetary easing is entered into.

There are risks to this outlook of course, such as the need for a sustained run of lower CPI prints as well as a material weakening in the labour market being seen, both of which are so far proving elusive. But the body of evidence is growing that these two requirements for easing will be delivered this year, removing any impediment from the FOMC taking action.