Strong Fundamentals Are Supporting The Economy

There is a commonly held belief that economic expansions do not naturally come to an end due to their age but rather meet their demise at the hands of the Federal Reserve. If this theory holds true, then the U.S. economy appears to be outpacing its potential assailant this year.

  • Consistent job growth and robust consumer spending serve as the most recent indicators that the economy has proven surprisingly resilient to the Federal Reserve's most aggressive interest rate hikes in the past four decades.
  • This, despite the ongoing effects of the pandemic and the global supply shocks (war in Ukraine, China's pause) which have pushed some major economies (e.g. Germany) into a recession.

Continued Growth

According to the Labor Department, employers added 3.1 million jobs over the last 12 months, including 187,000 in August. Although the unemployment rate increased from 3.5% in July to 3.8% in August due to more Americans entering the workforce. Three key factors explain why the U.S. economy continues to defy recession predictions.

  1. Firstly, a growing workforce and slower inflation have led to increased inflation-adjusted or "real" incomes for Americans this year, thereby driving more hiring and spending.
  2. Secondly, the unique circumstances of the Covid-19 pandemic disrupted spending patterns, resulting in shortages of goods, housing, and labor. This created significant pent-up demand that, for now, appears less sensitive to higher interest rates.
  3. Thirdly, the government initially injected substantial cash into the economy and maintained historically low interest rates, enabling businesses and consumers to secure lower borrowing costs. Subsequent legislation, such as the Inflation Reduction Act and the $53 billion Chips and Science Act, further bolstered federal spending and encouraged additional private-sector investment in manufacturing.

However, there are some risks to the outlook. Rising interest rates could eventually slow economic growth by making it more expensive for businesses to borrow money and invest. Weaker global growth could also weigh on US growth. Geopolitical risks, such as the war in Ukraine, could also disrupt the global economy and hurt US growth.

The Fed Gets Some Breathing Room

It's widely anticipated that the Fed will hold off on another interest rate increase at the September meeting, keeping the federal funds rate between 5.25% and 5.5%. Experts like Gargi Chaudhuri, head of iShares investment strategy Americas at BlackRock, suggest that the Fed doesn't need to be overly aggressive anymore and should allow the already restrictive rates to continue working.

  • President Joe Biden praised the strong job growth and cited the latest jobs report as evidence that inflation could decrease without significant labor market losses.
  • Job openings have decreased to their lowest level in about two years, and fewer Americans are quitting their jobs, as indicated by data from the Bureau of Labor Statistics.

Delaying Further Rises

When coupled with an inflation report showing slower price increases despite strong consumer spending this summer, economists and investors believe the Fed can afford to delay further tightening measures.

  • Omair Sharif, president of forecasting group Inflation Insights, is worried about the resurgence of inflation in the fourth quarter, particularly in sectors like the car market and health insurance costs.
  • He believes there's a risk of the core consumer price index rising from its current level of around 4.7% to approximately 3.5% by year-end, prompting another potential rate increase as late as December.

If the Fed skips a September rate increase, it will maintain the gradual tightening pace initiated this summer when the central bank paused its 10 consecutive months of rate hikes in June and opted for a quarter-point increase in July.

Disclaimer

Please note that Benchmark does not produce investment advice in any form. Our articles are not research reports and are not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.

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Photo by Steven Abraham / Unsplash.