Mixed signs of a cooling economy as Fed continues balancing act

By Joe Higgins, Quest 4 Quality

  • GDP expands at an annual rate of 2.6% in the third quarter, beating expectations
  • Consumer spending was up 1.4% but slowed from the two previous quarters
  • Mortgage rates surpassed 7% last week, putting a damper on the housing market

This month’s column largely involves gross domestic product (GDP). But before I go there, I would like you to understand the slow dance the Federal Reserve is doing in its effort to bring down runaway inflation and, at the same time, keep jobs plentiful for Americans.

Inflation is running historically high at over 8% and unemployment is historically low at 3.5%. The Fed has raised interest rates five times since mid-March and two more rate hikes are expected by year’s end. The thinking is that raising rates will cool off an overheated economy and allow inflation to settle into the 2% targeted level without causing massive job losses.

Yet third-quarter GDP rose at a 2.6% annual rate after a contraction in the first half of this year, beating expectations of a 2.3% increase. While this sounds like great news, there were some overly concerning statistics in the report.

Consumer spending, which contributes 73% of GDP, was impacted by inflation, which saps the buying power of American families. Overall consumer spending was up 1.4% for the quarter but was down 2% from Q2. Prices, especially for food and gasoline, have made it difficult for many to balance an already precarious household budget, and the spending downturn will likely be consistent until year-end and beyond.

What’s more, mortgage rates have doubled in the past year, and last week rose above 7% for the first time in two decades, making it more challenging for the average consumer to afford a home. This brought on a deep contraction in home prices and construction, as reflected in residential investment, a barometer used by economists to predict the housing sector. Residential investment was down 26% in Q1 and 18% in Q2, meaning new home construction will likely continue to fall.

This all begs the question, “Are we already in a recession?” The organization that formally calls a recession is the National Bureau of Economic Research, but given our recent numbers, I don’t see one currently. Although we started the year with two negative quarters of GDP, which is the classic definition of recession in most economists’ minds, the third quarter figures are a respite from those fears. Jobs are plentiful, consumer spending is still decent and the economy expanded by 2.6%.

There is, however, a greater chance for recesssion in the first half of 2023. The reason a recession is likely in the near term is that last quarter’s growth came from a decline in the trade deficit. Exports (which improve GDP) increased 14% while imports (which detract from it) dropped by 7%. But that will not happen again; exports will slow and imports will resume a more typical pattern.

In addition, the U.S. Bureau of Economic Analysis said the significant increase in government spending that occurred in Q3 would not be repeated over the next few months. And, with consumer spending slowing down, and given its significant impact on GDP, it does not bode well for continued growth.

Also, historically, when the U.S. economy has experienced rising GDP, it has sometimes signaled the beginning of a recession.

I therefore believe that the economy will experience a mild recession in the first half of 2023.

The Bottom Line

There are some positives to the current economy:

  • The unemployment rate is at 3.5% and wages are rising at an annual rate of 5.2%. This is inflationary, however, and the Fed is trying to bring down job growth while maintaining a balance between lowering inflation and full employment. 
  • Spending is down month to month, but consumers are still shopping, traveling and buying home-related goods like furniture and appliances.
  • Manufacturing is robust, as this month’s ISM Manufacturing Index confirmed. The Index registered 50.9, which indicates expansion and represents the 28th month of growth.

So I am going to go out on a limb here and say it is possible for Fed Chair Jerome Powell to pull off his so-called “soft landing,” which would mean keeping the economy going while raising interest rates. It would be a stretch for the Fed, though; in 1980, Paul Volker tried it and caused two recessions in a row, something we called a double-dip recession.

But not to worry — this time around the recession will be more like a correction, and nothing like 2008.

Joe Higgins is a 45-year veteran of GE and Whirlpool Corp. who brings his experience to bear as a business consultant, public speaker, AVB keynoter and YSN contributor. Visit his website, Quest 4 Quality with Joe, at www.q4qwithjoe.com.

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