There are multiple factors contributing to the recent surge in economic activity. Firstly, the combination of milder inflation and persistent wage growth is stretching the purchasing power of individuals. Ian Shepherdson, the chief economist at Pantheon Macroeconomics, estimates that between December and June, real incomes, adjusted for inflation and taxes, surged at an annualized rate of 7%.

  • This increase boosted the household savings rate from 3.4% in December of the previous year to 5.3% in May. It added to the approximately $1.2 trillion in savings accumulated during pandemic-era stimulus programs.
  • In the third quarter, households started to deplete these savings, leading to increased spending. Consequently, the savings rate dropped to 3.9% in August.
  • The reduction of recession concerns is another factor encouraging households to spend more.

The economy seems to have rebounded from the setbacks faced by Silicon Valley Bank and Signature Bank earlier in the year, making people more confident about their spending habits, as noted by Marc Giannoni, the chief U.S. economist at Barclays.

No Recession?

Economists, who had been predicting a recession for the past year, now believe, according to recent surveys, that the economy is likely to avoid a downturn in the next 12 months. Surprisingly, the Federal Reserve's interest rate hikes haven't had the expected cooling effect. This could be because businesses and households locked in lower interest rates during the pandemic when the Fed's short-term rate target was close to zero, as explained by Powell.

  • Economists at Jefferies found that corporate interest expenses as a percentage of revenue have been decreasing over the past year, despite the Fed's rate increases.
  • Additionally, many homeowners refinanced during the pandemic, lowering mortgage payments and increasing household savings by approximately $400 billion through the second quarter, as reported by the New York Fed.

Economists are pointing to three possible scenarios for the future of the economy:

  1. The current momentum may be short-lived. Although hourly wages are rising, workers are putting in fewer hours, leading to a decrease in inflation-adjusted weekly wages. If this trend continues, households might cut back on their spending.
  2. The economy could remain hot, causing inflation to rise once again. This could prompt the Fed to further increase interest rates, potentially slowing the economy and raising the risk of a recession.
  3. The economy could sustain strong growth while keeping inflation in check. This would be an ideal situation, implying increased productivity, which would allow the economy to produce more goods and services without inflation-inducing bottlenecks. In this case, the economy could continue to grow without the need for the Fed to raise interest rates.

There are some positive signs, such as a higher proportion of working-age individuals participating in the labor force and increased investment in clean energy sources with the help of federal subsidies. Nevertheless, many economists remain cautious about fully embracing this optimistic scenario.

A Fed Pause

A prominent central bank official has advocated for an extension of the Federal Reserve's pause on interest-rate increases, citing mounting evidence that heightened borrowing costs could hinder economic growth, despite recent indications of strength in hiring and spending. Philadelphia Fed President Patrick Harker expressed his belief that the central bank could likely postpone its decision on the impact of the rapid rate increases implemented over the past 20 months until early next year to assess their effectiveness in curbing inflation.

  • Harker emphasized the need for patience during this period, suggesting that the pause might extend for an indeterminate duration, depending on evolving economic conditions. He pointed out that while recent economic data has shown surprising vigor, anecdotal feedback from various businesses indicates a slowdown.
  • For instance, there are reports from bankers about an increase in business loans reaching their maturity, which would necessitate renewal at significantly higher interest rates. Concerns have arisen regarding the ability of some businesses and their models to withstand these elevated rates. Harker, a former university president, expressed these concerns.
  • The Federal Reserve's most recent interest-rate hike occurred in July, bringing the range to 5.25% to 5.5%, marking a 22-year high. In the past week, several officials have indicated their comfort with maintaining rates at the October 31-November 1 meeting, continuing the halt in rate increases initiated in September.

Additionally, the Federal Reserve has been gradually reducing its $8 trillion asset portfolio by $1 trillion over the past year by allowing Treasury and mortgage-backed securities to mature without replacement. This portfolio reduction contributes to a form of monetary policy tightening, as the U.S. Treasury must find new buyers for the securities when they mature.

Doing Something By Doing Nothing

Harker emphasized the importance of allowing economic mechanisms to operate naturally, stating that by doing nothing, the Federal Reserve was doing something and that their actions have been significant.

  • Harker, who has not dissented in rate-setting meetings during his terms as a voter in 2017, 2020, and this year, described the decision to support the July rate increase as a "close call.".
  • He stated that a "stark turn" in economic data, particularly signs of inflation reacceleration, would be required for him to favor rate increases once more.
  • Although recent economic reports, such as the strong September employment report from the Labor Department and robust retail sales data from the Commerce Department, have been positive, measures of underlying inflation have notably slowed since June. Core prices, which exclude volatile food and energy components, experienced a decline in their six-month annualized rate from 4.8% to 3% in August, as per the Commerce Department.

Harker also expressed support for initiating discussions on the eventual slowing of the central bank's asset portfolio runoff, which is occurring at a faster pace than in late 2018 and early 2019. The central bank's aim is to reduce its holdings, which will ultimately drain bank reserves from financial markets. However, the timing of when reserves might reach levels low enough to create competition among banks, potentially driving up overnight lending rates, remains uncertain, as seen in 2019.


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