There will be a soft landing for the US economy. Analyses
There are five reasons in favor of a "soft landing" of the US economy: here they are. The analysis of Jeffrey Cleveland, Chief Economist of Payden & Rygel
As evidenced by the Bloomberg and Blue Chip polls, the risk of a recession in the next twelve months is so shared by the consensus of market participants as to cause nervousness, even if, as Paul Samuelson said, "economists have predicted nine of the last five recessions ”, which invites us to take their economic forecasts with caution (as also demonstrated by the fact that last year they considered inflation only transitory).
To tell the truth, the recession alarm does not seem unfounded, also given its historical relationship with the Leading Economic Indicator (LEI): in fact, the LEI reached a record peak in February 2022, to then drop by 5% in the nine following months and had also reached its maximum 14 months before the recession caused by the pandemic, in 2020.
Another sign of weakness emerges from consumer surveys: for example, in 2022 sentiment in the United States collapsed. However, since everyone now expects a recession – and the stock market has lost about 25% since its peak over the course of 2022, while the average in recessionary periods is a 33% plunge – we would like to consider another possible outcome: a “soft landing” for the US economy in 2023.
What makes a “soft landing” possible?
First of all, it should be noted that "soft landing" does not mean "soft recession", but rather a situation similar to that experienced by the US economy in 1994-1995, when GDP growth slowed due to aggressive rate hikes by the Fed , but without leading to a recession. The Fed raised its policy rate by 300 basis points between early 1994 and the spring of 1995, but the US economy expanded for another five years before heading into the 2001 recession. soft”, the unemployment rate remains low – or even declining – despite expectations for a slowdown in job growth in the year ahead. There are 5 reasons, therefore, which indicate a more optimistic scenario for 2023.
1 – The US is not yet in a recession
First, and contrary to popular belief, the US is not yet in a recession. The National Bureau of Economic Research (NBER) determines the start and end dates of a recession based on key economic indicators, including GDP. Eight of the nine key indicators monitored have reached new cycle highs in the latest monthly or quarterly reports. The US labor market, in particular, continues to show some resilience, while the unemployment rate should be on the rise if we were in a recession.
Historically, despite being considered a “lagging indicator,” an increase in the unemployment rate of 0.5% is consistent with the official start of a recession. Instead of increasing, however, unemployment in the United States has fallen by more than a percentage point over the past year, reaching 3.5%, which is a 50-year low. In 2022, companies hired more than 3.8 million workers, equivalent to about 400,000 jobs per month. Even if job growth slows to less than half this pace in 2023, the unemployment rate will remain low and possibly decline.
2 – The strong demand for labor will not continue
In 2021, the US economy looked hectic and “overheated”. Now, however, it could cool down in an orderly manner consistent with the hypothesis of a soft landing. New jobs increased in 2021, mainly due to the labor shortage due to the pandemic, to which companies have responded by increasing vacancies and offering more competitive wages to attract talent.
As a result, wage growth has skyrocketed, especially for workers who have decided to change jobs. Critical evidence of this strong labor demand is provided by the monthly data on voluntary resignations: the count of workers who voluntarily quit, probably in search of better opportunities, increased in 2021, before stabilizing in 2022. Demand also is expected to shrink, leading to lower worker turnover and moderation in wage growth – a dynamic that could ease fears of a wage-price spiral.
3 – We must not fear wage growth
Wage increases will continue to support US consumption and stimulate economic growth. In September 2022, aggregate compensation and wage payments grew 8.2% year-over-year, outpacing other measures of core inflation, which fluctuated between 5% and 6%. Income growth is then strongly correlated with US consumer spending and provides a decisive boost to general economic activity.
4 – Eliminate excesses
We saw a correction in 2022: GDP contracted in the first half of the year and some financial bubbles burst. Cryptocurrencies, real estate and the tech sector suffered substantial losses, followed by a series of layoffs. As a result, some excesses have been eliminated from the economy and the financial system, laying the foundations for healthier and more balanced growth.
Residential construction has enjoyed enormous valuation growth during the pandemic, well above what the average American household could afford, but in 2022, real estate activity sagged as interest rates rose. While most households who have taken out mortgages benefit from 30-year fixed-rate loan terms, which protect them from the recent rate hike, construction of new homes has declined significantly, dampening the housing market's momentum.
5 – A shelter from the storm
Finally, housing remains a key component of the consumer price index (CPI). The housing component, which includes rents for apartments and single-family houses, explains 40% of the increase in core inflation over the past 12 months (+6.6%). However, the shelter component follows house prices with some lag. With the sharp increase in mortgage rates, prices have peaked and are expected to slow down in 2023. With some lag, the pressure on rents should also decrease accordingly.
We therefore expect to see signs of a slowdown in core inflation by the second quarter of 2023. If it eases with a still low unemployment rate, Fed policy-makers could ease monetary policy and suspend rate hikes . The US central bank has been aggressively raising rates in 2022, but may pause and not hike much in 2023. Consistently lower inflation will boost real incomes and consumer spending, with the potential to extend the duration of the economic cycle.
The best case scenario for investors
In summary, we rely on the timeless wisdom of Benjamin Graham: "The intelligent investor is a realist who sells to optimists and buys from pessimists". Since most investors are already aware of the bad news, alternative outcomes for the economy, including a “soft landing”, are also worth considering. Moderate GDP growth of between 1% and 2%, core inflation down to 3%-4%, an unemployment rate that remains low and healthy wage growth – without a surge – are the elements that could point to a best-case scenario for investors in 2023. In this “soft landing” scenario, the Fed approaches the Federal Funds benchmark rate, by around 5% by Q1 2023, slowing each increase from 50 to 25 basis points, before stalling in the second quarter.
Treasury yields usually peak as the Fed approaches its terminal rate. At that point, market participants will feel more comfortable holding risky assets, including US equities. Furthermore, credit sectors in the bond market, such as US high-yield corporate debt, which offers yields around 9%, could benefit, especially if the most anticipated recession in history is avoided.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/economia-americana-atterraggio-morbido/ on Mon, 20 Feb 2023 06:31:05 +0000.