by Eugenio J. Alemán , Chief Economist, Raymond James
Chief Economist Eugenio J. Alemán discusses current economic conditions.
The short answer to this question is, no, not at all.
The long answer, however, is trickier than it seems. So far, the majority of the sectors of the economy that have a higher sensitivity to high interest rates have reacted accordingly to the Federal Reserve’s (Fed) monetary tightening. That is, several investment sectors of real gross domestic product, have been in negative territory since early 2021, as the table below clearly shows. As an example, real residential investment has been declining since the second quarter of 2021, unabated. Nonresidential investment in structures has also been in negative territory since the second quarter of 2021 but managed to come back into slightly positive territory during the last quarter of 2022, up 0.4% on an annualized, seasonally adjusted basis. Nonresidential investment in equipment has been hit-or-miss but has posted three negative quarters since the third quarter of 2021.
So far, this weakness in investment has not been sufficient to bring the U.S. economy into a recession and our take is that we are probably close to the bottom in terms of investment weakness in this cycle. The reason for this is that housing is the most sensitive sector to higher interest rates and thus it adjusts the fastest to these higher rates. This means that the two more rate increases we expect in March and May would probably have marginal effects on the investment side of the U.S. economy.
Now it is the turn of personal consumption expenditures (PCE), but particularly of the PCE goods, as PCE services has continued to expand because this sector is still recovering from the depths of the COVID-19 induced recession. Thus, the weakness we are going to see during the first quarter of the year will probably be related to how deep and strong is the weakness in the consumption of goods and if it overwhelms the continuous improvement in the service side of the economy. Last week’s January employment as well as ISM Services numbers could be pointing to a recovery in the consumption of services during the first month of the year. This means that we should pay close attention to next week’s monthly retail and food services report.
However, there is also the possibility that services consumption could start to dwindle during the second and third quarters of this year if interest rates continue to increase. The retrenchment in goods consumption is probably a combination of the slowdown in the consumption of goods after a very strong increase related to the COVID-19 pandemic but it may also be due to the recent increase in the rate of interest on saving deposits, which has increased considerably during the last several months after many decades of an almost zero rate of interest.
Recall that the rate of interest acts as the opportunity cost of saving/consuming. That is, if the rate of interest on savings is high, individuals would tend to save today in order to consume more tomorrow. However, if the rate of interest on savings is low, the opportunity cost is very low and thus individuals prefer to consume today and not save. This is what has happened since the early part of this century when interest rate have remained very close to zero.
This means that this equation is changing, and Americans are probably starting to consider, for the first time in several decades, whether to postpone current consumption in order to save and consume later in their lives. We believe that whether there is going to be a recession this year will depend, fundamentally, on the actual effect of this recent increase in the interest rate on savings accounts and on current consumption.
The last component of real GDP that will be important for determining this year’s economic performance is the external sector, or what is called net exports. That is, real exports minus real imports of goods and services. Last year was a very good year for exports because of the effects of the Russia-Ukraine war as US exports of energy increased considerably while imports of goods and services weakened considerably after a very strong first quarter of the year. These helped keep the contribution of net exports to GDP positive. However, the appreciation of the U.S. dollar, which normally acts with a lag, plus the improvement of the energy situation in Europe has diminished the importance of this component over GDP growth. Thus, we expect a lower contribution from net exports to growth this year, which could contribute to weaker economic growth.
Changes to Our Economic Forecast
We have adjusted our economic forecast for this year and next year. As we explain in the prior section, the possibility of a soft landing has increased considerably and even though we think that a recession is still possible later this year, it is not a done deal, especially with the strength we are still seeing in the jobs market.
We are forecasting annualized growth during the first quarter of the year at just 0.3% compared to the fourth quarter of last year because while the economy grew 2.9% in Q4 2022, personal consumption expenditures (PCE), which is about 70% of the US economy was very weak during the last two months of last quarter. Thus, the year started on a weak note. This means that the first quarter will be hit or miss in terms of growth.
Thus, our forecast has improved compared to what we had before, but we still see a recession starting in Q2 of this year. However, we now expect the decline in GDP to be even milder than what we were expecting before. This means that, for the whole of 2023, we now expect growth of 0.5% compared to 0.0% before while we expect growth in 2024 to be 1.1% rather than 0.8%. Both rates of growth will be below the potential output growth of 1.8%, which means that the Fed will still be able to keep inflation on a disinflationary path during 2023 and 2024.
Economic and market conditions are subject to change.
Opinions are those of Investment Strategy and not necessarily those of Raymond James and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Last performance may not be indicative of future results.
Consumer Price Index is a measure of inflation compiled by the U.S. Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.
Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.
Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.
The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.
Leading Economic Index: The Conference Board Leading Economic Index is an American economic leading indicator intended to forecast future economic activity. It is calculated by The Conference Board, a non- governmental organization, which determines the value of the index from the values of ten key variables
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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.
FHFA House Price Index: The FHFA House Price Index is the nation’s only collection of public, freely available house price indexes that measure changes in single-family home values based on data from all 50 states and over 400 American cities that extend back to the mid-1970s.
Expectations Index: The Expectations Index is a component of the Consumer Confidence Index® (CCI), which is published each month by the Conference Board. The CCI reflects consumers' short-term—that is, six- month—outlook for, and sentiment about, the performance of the overall economy as it affects them.
Present Situation Index: The Present Situation Index is an indicator of consumer sentiment about current business and job market conditions. Combined with the Expectations Index, the Present Situation Index makes up the monthly Consumer Confidence Index.
Pending Home Sales Index: The Pending Home Sales Index (PHS), a leading indicator of housing activity, measures housing contract activity, and is based on signed real estate contracts for existing single-family homes, condos, and co-ops. Because a home goes under contract a month or two before it is sold, the Pending Home Sales Index generally leads Existing-Home Sales by a month or two.
DISCLOSURES
Import Price Index: The import price index measure price changes in goods or services purchased from abroad by
U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).
ISM New Orders Index: ISM New Order Index shows the number of new orders from customers of manufacturing firms reported by survey respondents compared to the previous month.ISM Employment Index: The ISM Manufacturing Employment Index is a component of the Manufacturing Purchasing Managers Index and reflects employment changes from industrial companies.
ISM Inventories Index: The ISM manufacturing index is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories.
ISM Production Index: The ISM manufacturing index or PMI measures the change in production levels across the
U.S. economy from month to month.
ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.
Source: FactSet, data as of 12/29/2022
