U.S. economy on the road to RECOVERY - July 3

[dan_s]

From one of our economist based in New York.

Executive Summary: Instead of the economywide recession that was widely expected to result from the Fed’s monetary tightening, recessionary weakness rolled through different areas of the economy at different times. Now that rolling recession is turning into a rolling recovery.
> Accordingly, we’re raising our Q2 real GDP forecast from 1.0% to 2.0%, followed by 2.0% in Q3 and Q4.
> We now see a 75% chance of a soft landing (up from 70%)—subject to change depending on what the Fed does, which depends on what inflation does.
> We expect inflation to continue to moderate, with a headline PCED rate closer to 3.0% by year-end, down from 4.6% in May.

Details:

US Economy: Rolling Along. The Fed has raised the federal funds rate by 500bps since March of last year and seems to be on course to raise it by another 50bps over the rest of this year. Despite the monetary tightening, the US economy has avoided falling into an economy-wide recession. Instead, it has been experiencing a rolling recession since early last year, rolling through various industries at various times.

Now the economy is showing signs of experiencing a rolling recovery. Growing confidence in the resilience of the economy has been one of the main reasons why the stock market has been so strong since October 12, with the S&P 500 up 24.4%, the Nasdaq up 32.4%, and the S&P 500 Transportation index up 21.0% since that date.

Let’s review some of the signs of that resilience and why we think that the rolling recession is turning into a rolling expansion:

(1) GDP growth has slowed but remained positive. It has been a soft-landing for real GDP so far. Here are the q/q increases over the past three quarters at a seasonally adjusted annual rate (saar): Q3-2022 (3.2%), Q4-2022 (2.6%), and Q1-2023 (2.0%). The most recent quarter’s number was revised up from an initial estimate of 1.1%.
> Real final sales growth rates for the past three quarters were mostly strong at 4.5%, 1.1%, and 4.2%.
> Real consumer spending remained remarkably resilient at 2.3%, 1.0%, and 4.2% notwithstanding rapidly rising interest rates. That’s because employment gains remained robust and consumers spent some of the excess saving they had accumulated during the pandemic.

(2) Residential investment has been in a recession for the past eight quarters, except for multi-family housing. It first turned negative during Q2-2021, before the Fed started raising interest rates during March 2022. It fell 22.3% through Q1-2023. Contributing to the decline over this period were single-family housing (-25.6%), home improvements (-17.9%), and real estate brokers’ commission (-33.6%). On the other hand, multi-family housing held up well, rising 5.4%.

Both new home sales and single-family housing starts soared during May by 12.2% and 18.5% m/m, respectively. There’s lots of pent-up demand for housing and a significant shortage of inventory. That may be enough to end the housing recession even if mortgage interest rates remain elevated. The Atlanta Fed’s GDPNow tracking model is currently estimating a 0.7% increase in residential investment during Q2, up from -4.0% during Q1.

(3) Capital spending on structures declined for six quarters (Q2-2021 through Q3-2022), but has risen for the past two quarters (through Q1-2023). The latest rolling recession in capital structures was in spending on commercial, health, power, and communications facilities. That weakness was partially offset by mining exploration, shafts, and wells structures. Spending on manufacturing plants was flat and depressed following the pandemic lockdowns, but it has surged over the past couple of quarters thanks to onshoring.

(4) Capital spending on equipment declined during the past two quarters, but R&D and software spending have been strong. The weakness was widespread among information processing, industrial, transportation, and other equipment. We are expecting information processing equipment spending to turn up soon. Meanwhile, business spending on software and R&D in real GDP rose to new record highs and should continue to do so. The Atlanta Fed GDPNow model is currently estimating that business equipment spending rose 6.7% (saar) during Q2.

(5) Inventories rose sharply from Q4-2021 through Q4-2022, but inventories should no longer be a drag on real GDP going forward. Much of that was unintended, as consumers pivoted from buying goods to purchasing services. Their goods buying binge during 2021 depleted inventories, causing wholesalers and retailers to order more merchandise, which piled up as unintended inventories when they finally arrived. Inventory investment in real GDP dropped sharply from $136.5 billion (saar) during Q4-2022 to $3.5 billion during Q1-2023, suggesting that the inventory overhang has been resolved. That drop in inventory investment reduced real GDP during Q1 by 2.14 ppts. Inventories won’t be a negative contributor to real GDP growth over the remainder of this year, in our opinion.

(6) Total government spending on goods and services in real GDP has been rising fast for three quarters (through Q1-2023) after falling for five (Q2-2021 through Q2-2022). It has been rising at a faster pace than real GDP for the past three quarters, at 3.7%, 3.8%, and 5.0%. That’s likely to continue as the Biden administration’s program to rebuild national infrastructure cranks up.

(7) Consumers’ spending on services should continue to rise, more than offsetting any weakness in their spending on goods. The latter peaked at a record high during March 2021. It was down 3.9% through May of this year, though it has been essentially flat since H2-2021. Over this same period (since goods spending peaked), spending on services rose 9.5% to a new record high. Actually, during Q1-2023, consumers’ spending on goods in real GDP rose 6.0% (saar), led by a 16.3% jump in spending on durable goods. Their spending on services rose 3.2%.

Inflation-adjusted disposable personal income (DPI) has been trending higher over the past 11 months through May. We expect that real DPI will continue to rise along with employment and real wages. We also predict that the personal saving rate will remain relatively low. It is widely expected that it will move higher and depress consumers’ spending once they deplete the excess savings they accumulated during the pandemic. We disagree, because retiring Baby Boomers have accumulated a much greater $75 trillion in “excess” net worth and we believe they intend to spend quite a bit of it during their retirement years.

(8) Our rolling recovery scenario adds up to no recession ahead.
We are updating our soft-versus-hard-landing subjective odds from 70/30 to 75/25. We are raising our forecast for Q2’s real GDP from 1.0% to 2.0% and maintaining this growth-rate projection for H2-2023.

We might have to return to 70/30 or even 60/40 for 2024 if the Fed turns too hawkish in response to the resilience of the economy in general and the labor market in particular. Of course, much will depend on inflation. If the headline inflation rate continues to moderate and the core rate shows more signs of moderating, then the Fed should become less hawkish even if the economy continues to defy the recession forecasters.
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MY TAKE: As I have posted here many times; with the unemployment rate so low (anyone that wants to work can find a job), I see very little chance of a recession in the U.S. There may be a mild recession in Europe, but a Global Recession significant enough to lower oil demand seems highly unlikely to me. All that is needed for oil prices to move higher is less FEAR of a recession. Let's put the "Gloom and Doom" behind us.

[ChuckGeb]

How many economists do you have? A intern or otherwise?