Despite Recession Fears, the US Economy Continues to Disappoint Its Skeptics
Over the first two quarters of 2023, everything is coming up roses for the United States economy. First, there was the upward revision in US Real GDP growth for the first quarter, from 1.3% to 2.0%. Then, US Real GDP growth came in at a decidedly strong 2.6% pace. That's a rate of growth that you would expect in the midst of an economic expansion, not the late stages of one. The chart below shows the rebound in real growth over the first half of 2023.
That's real growth, in excess of inflation. Headline inflation as measured by the Federal Reserve's preferred price index, the Personal Consumption Expenditures (PCE) index, was subdued, coming in at a lower-than-expected 3.0%. The PCE represents about two-thirds of Americans' spending, so it's a pretty comprehensive measure of how the things Americans pay for change in price as well as a strong driver of their economy.
But that's about half of what it was at this time last year, so it feels like progress on the inflation front--although the prior year's reading suffered from base effect, and this year's suffers from anchoring bias. Measures of core inflation, or inflation excluding volatile inputs like energy and food, which tend to have a lot of price movement, paint a more pessimistic picture. PCE excluding food and energy came in at a 4.1% YoY increase, which is heading in the right direction, but indicative that core inflation remains uncomfortably high.
Most of the improvement in inflation comes from a drop in the prices of goods, an indication that supply chain pressures have eased and we have returned to a moderate inflation environment. Prices for goods decreased 0.6 percent. Now the bad news: prices for services increased 4.9 percent, an indication that we're not out of the woods yet when it comes to wages. In the "Good News for the Economically Marginalized", food prices increased only 4.6 percent but, more importantly, energy prices decreased 18.9 percent.
Current research has cast doubt on the theory of the wage-price spiral we've written about before, which is the positive, self-reinforcing feedback loop between wage gains and consumer prices. It may be that expected inflation does not do much to increase wage gains. Whatever the case, it is clear that inflation expectations remain anchored over the 1–5-year horizon, with inflation expected to revert to the 2% level over the next 3-5 years.
From the perspective of robust, broad-based growth, and high-but moderating inflation, the data-driven investor has to conclude that macroeconomic conditions have improved, and that widespread calls for recession could have been premature or entirely inaccurate. As we've written before, recession as it is understood in the United States and defined by the National Bureau of Economic Research, is largely a labor-market phenomenon. Just because economic growth slows or even contracts for two consecutive quarters doesn't mean that a recession is under way.
By this metric, the US economy is nowhere close to slowing down: job gains continue to impress (209,000), unemployment remains historically low (3.6%), workforce participation rates have recovered (62.6%), wage gains are robust (4.5%), and the ratio of jobs available to job seekers (1.6) all indicate a surprisingly strong US Labor market.
Furthermore, savings rates have been and remain high, while credit use is declining, indications that the average consumer isn't overextended. Lastly, consumer confidence continues to rise. Whatever the prognosticators might suggest, recession simply isn't on the horizon.
Workers retain bargaining power, which spells good news for the US economy, two-thirds of which is driven by consumer spending. If workers feel comfortable with their leverage in the market for labor, then they are less likely to pull back on spending. With inflation falling, the consumer is likely to continue to spend and to replenish personal savings. At increasing deposit rates, consumers should begin to feel richer as they watch their bank account balances grow. This wealth effect may drive additional consumption in the future.
The economy is healthy and in growth mode, which generally presages profitability for US companies. As earnings come in, it will be worth attention to see if current equity valuations are justified by corporate profitability--and with those profits, their lofty valuations.