U.S. Economy Defies Expectations with Strong Growth, but Recession Looms on the Horizon
The U.S. economy continues to defy predictions of a slowdown and is actually growing at an even faster pace. However, this robust growth does not guarantee that a recession is not on the horizon. History has shown that the U.S. often experiences fast growth just before a downturn.
The good news is that the gross domestic product (GDP), the official measure of the economy, is expected to surpass 4% or even 5% annual growth in the third quarter. Economists surveyed by The Wall Street Journal predict a 4.7% GDP for the quarter, while top forecasters anticipate even faster growth, with S&P Global estimating 5.6% GDP and the Atlanta Federal Reserve GDPNow project projecting 5.4%.
This level of growth is significant, as GDP only exceeded 5% once between 2010 and the start of the pandemic in 2020. It is a surprising turn of events, as the economy was expected to slow down in response to rising interest rates. The Federal Reserve has been increasing borrowing costs in an effort to curb inflation, which usually dampens consumer spending and business investment – the twin engines of the economy.
To some extent, the Fed’s strategy has had an impact. Home sales and construction have declined due to the highest mortgage rates in decades, and manufacturers have seen a decline in purchases of goods and big-ticket items. The annual rate of inflation has also tapered to 3.7% as of September, down from a 40-year high of 9.1% in 2022.
However, spending and investment have not decreased as much as expected, and there are two main reasons for this. The first is a strong labor market with unemployment hovering just below 4%. Most Americans who want a job have one, allowing them to continue spending, particularly in areas such as travel, recreation, leisure, and hospitality.
On the industrial side of the economy, the Biden administration’s subsidies for green energy and bringing manufacturing back to the U.S. have benefitted manufacturers. Additionally, increased military aid to Ukraine has led to the need to replace equipment, weapons, and ammunition.
Overall, the government’s financial support has prevented manufacturers from experiencing a significant decline. Government spending could contribute as much as 0.6 percentage points to third-quarter GDP. Furthermore, the sharp decrease in the trade deficit is likely to add 1.0 percentage point or more to GDP, and a rebound in inventory production would provide further growth.
While the economy seems to be performing well at the moment, there are reasons to be cautious. Consumers may struggle to maintain their current spending pace as their incomes are barely rising faster than inflation. Businesses are proceeding cautiously due to higher borrowing costs, and banks are more reluctant to lend.
Other factors contributing to economic restraints include higher gasoline prices and a surge in long-term interest rates, making it more expensive to make major purchases like houses, cars, and appliances.
Many forecasters anticipate that the economy will begin to soften in the final months of 2023. S&P Global, for example, initially projects 1.7% growth in the fourth quarter. It is important to note that the strong growth rate in the third quarter does not eliminate concerns about a recession. History has shown that the economy has expanded rapidly just before prior recessions.
For instance, the economy grew at a solid 2.5% pace before the 2007-2009 Great Recession, and GDP experienced a frothy 4.4% growth in the first quarter of 1990, just months before a recession began.
Many of the same economic headwinds that led to earlier predictions of a recession by Wall Street analysts are still in place. Some economists, like those at the Conference Board, still believe a brief recession is likely in 2024. Others, including TS Lombard’s chief economist Steve Blitz, remain vigilant, stating that a recession is still on the horizon, albeit less severe than the 2008-2009 event.