economic update

Quarterly Economic Review and Outlook

BY: METRO

Headline inflation fell to 4 percent but still above the FED’s target rate. Labor markets remain unusually tight and employment gains have been robust. The housing market seems to be on the upswing despite high interest rates. Shelter costs add to and complicate FED efforts to slash inflation. GDP growth has been hardier than expected with that momentum likely to carry into the second half of 2023.

Gross Domestic Product (GDP)

Inflation adjusted GDP increased at an annual rate of 2.0% in the BEA (Bureau of Economic Analysis) final estimate of Q1 2023 growth. This trend-like growth performance for the US exceeded earlier predictions which projected a strong likelihood of negative growth or more recent estimates of national output, including the BEA’s “second” GDP estimate of 1.3%. On an industry basis, manufacturing sector GDP sagged -0.7% while service sector GDP rose 2.6% in Q1. Forward-looking indicators such as the PMI (Purchasing Managers Index) confirm and anticipate the production of goods will contract further, but the service sector to still exhibit strength in coming months.

Bottom line: Upward GDP revisions to trend-like performance levels in Q1 suggest that the US was likely to carry that momentum forward into Q2 with GDP advancing near a 2% annual rate once again. As Q3 begins with the calendar flipping to July, monthly economic data suggest a bit of slippage in real GDP to 1.5% growth.

Consumer Sentiment

Consumer spending led the way in bolstering a strong revision to Q1 GDP. PCE (personal consumption expenditure) surged ahead at an above-average trend of 4.2% annual pace. This degree of spending is likely unsustainable given anticipated economic headwinds. The latest sentiment reading rose 8.8% in June, reflecting more optimism with inflation continuing to recede and the nation’s debt ceiling crisis being resolved. However, consumer sentiments are still far below normal, wary of inflation and what actions the FED might take to bring down inflation.

Bottom line: Sentiments are likely to continue to improve incrementally if the US avoids a recession, but the low readings suggest Americans are still bracing for that as a potential outcome. While more upbeat and still spending, households are likely to exercise more caution in the second half of the year as lingering inflation and the FED’s tightening of monetary conditions clamp down on expenditures.

US Labor Market

The FED’s efforts to slow US economic growth and impede inflation have not yet yielded the decline that central bankers had hoped. US growth has exhibited far greater resilience than expected, especially labor markets. At current rates of unemployment and job growth, the US labor market remains tight. The unemployment rate in the US has bounced around 3.5% since a year ago. US unemployment claims have edged up in recent months but one must squint hard at the data to see the trend. Unemployment remains near the lowend, offering little indication of weakness in US labor markets at this juncture of the business cycle. Employment has rebounded above pre-pandemic job levels and the job market continues to register strong monthly gains, although it is clear that annual growth has begun to slow with the latest labor report showing growth of 3%.

Bottom line: The US labor market continues to register strong monthly gains, enough to absorb jobless claims and hold down the monthly unemployment rate. With recent GDP and other economic indicators registering positive or tapered gains, the current strength in labor market conditions is likely to carry forward for a while longer. Expected weakness in the US labor market will be deferred to subsequent quarters this year.

Consumer Price Index (CPI) Inflation

The inflation rate in the US is easing but is stubbornly high. The 12-month headline CPI rate fell to 3.0% in June – a much steeper decline than anticipated and the lowest rate since March 2021. However, part of the decline owes to what economist call “base effects” and not so much the economic fundamentals cooling down as much as the recent decline might seem to imply. The drop in the June inflation rate comes as a statistical anomaly that saw inflation peaking at 9.1% exactly a year ago. The easing of headline inflation masks the fact that earlier price jumps are now embedded in today’s prices in which consumers must pay for basic groceries and other purchased items. Shelter costs, which is for most Americans the largest monthly expense, continues rising and adding to consumer woes.

Bottom line: Inflation continues to decline, but not fast enough. The FED has hinted that they expect inflation will be a concern into 2025 and said that they will remain vigilant and act according to what the data reveals as appropriate actions.

FED monetary policy

The FED stayed its hand and did not lift interest rates when they last met in June; however, the central bank is likely to lift rates in July because inflation is still deemed too high. FED officials have not been shy in signaling the need to raise the benchmark FED funds rate by +25 bp (basis points). Pundits also noted the likelihood of an additional +25 bp increase in September. Today’s FED fund rate is nearing the height of past rates that had been associated with downturns in the US. Squeezing the remainder of inflation down to the FED’s 2% target may require more difficult and riskier choices that might just lead to a downturn.

Bottom line: A combination of stronger than expected economic news is pushing the FED to consider lifting interest rates in July and again in early-September. The economy today seems less at risk of contracting, thus giving the FED leeway to be more forceful in curbing inflation.