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The economy has shown resilience this year with 2.1% GDP growth in the second quarter, following 2.2% in the first quarter.
One driver of the surprisingly upbeat growth: Business inventories were little changed, which suggests that companies are no longer as worried about declining future sales. They also started buying more autos. And manufacturing-related construction surged. Unfortunately, most sectors of the economy showed signs of slowing growth. Growth in consumer and government spending slowed. Housing is still weak. Exports declined as Germany and the U.K. have neared or fallen into recession. Imports of business equipment and supplies also dropped.
We expect a slowdown in the third and fourth quarters. But a recession may be avoided, with the odds of one in early 2024 at 30%. Consumer and business spending is expected to slow into next year, but perhaps not so much as to cause an outright recession. The economy’s resilience may be due in part to personal income growing at 4% after taxes and inflation, which is supporting consumer spending. Also, consumers and businesses still have good balance sheets, with much of their debt locked in at low interest rates. A recession is usually only declared when the economy contracts and the unemployment rate rises by at least a half percentage point. In the coming slowdown, we may sidestep that scenario.
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But, consumer expectations of future economic conditions are still poor. Businesses are likely to conserve cash and limit their spending. Export markets figure to weaken. Government spending will continue, but no major new spending programs to give growth a boost are on the horizon.
The banking system should be fine, but banks are going to be reluctant to press their luck with much additional lending after the recent rise in interest rates inflicted losses on banks’ portfolios of Treasury bonds. Instead, they appear to be in the process of tightening lending standards because of the many economic uncertainties.
The Federal Reserve elected to pause its interest rate hikes at its meeting on September 21, but it is still determined to combat inflation. Inflation is on a downtrend, but if it gets stuck at a level higher than 2%, the Fed will feel the need to raise rates again.
Every cloud has a silver lining: The slowing economy will gradually reduce inflation, and take the edge off the labor crunch and new car order backlogs, perhaps allowing supply to catch up with demand. If inflation does come down as expected, then the Fed might be willing to actually cut interest rates next year.
Source: Department of Commerce: GDP Data
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