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The US economy has had a good year. Not only has it evaded a widely expected recession, but growth has also accelerated and the inflation rate has halved. The US economy looks likely to grow by 2.5% this year against expectations in January of just 0.2%. Corporate profit margins are rising and almost 80% of US corporates that have reported their latest results have exceeded market expectations. Anyone who defied the gloom and bought US equities at the start of the year would have seen a gain of 17%.
Instead of slowing in the face of the biggest tightening of US monetary policy in 40 years, growth has accelerated even as it has ground to a halt in Europe. How can we explain this exceptionalism?
Part of the reason relates to the structure of US debt. US homeowners are insulated from the immediate effect of higher rates by holding 30-year fixed-rate mortgages. Only when they move, and refinance, do households feel the effect of higher mortgage rates. Corporates, especially larger ones, are increasingly insulated from the immediate effects of higher rates. In recent years, many US corporates have protected themselves against the risk of rising rates by borrowing at long-term fixed rates. High levels of consumer savings and corporate cash built up in the pandemic have also helped support growth, as has loose fiscal policy, with the Federal government running a sizeable deficit, equivalent to around 6% of GDP. The fact that the US was not dependent on Russian natural gas, and was, in any case, a relatively light user of gas, meant that last year’s energy crisis had less impact in the US than Europe.
There is no doubt that 2023 was a remarkable year for the US economy. The question is whether the good news will continue. This is where it gets murky.
I was on a call earlier this month where a senior US policymaker said it was possible to imagine that the US economy would continue to post good growth in 2024, or slow – or go into recession! The comment was not flippant. Views on the US outlook vary widely, going from ‘soft landing’ at one end to recession at the other.
The Economist magazine put the case for recession earlier this month. It argues that once US consumers exhaust their savings the effects of higher interest rates will start to bite, manifesting in falling house prices and higher unemployment. Weaker consumer spending will hit corporate revenues, pushing up bankruptcy rates. Banks holding long-term securities will come under pressure as they “have to raise capital or merge to plug the holes blown in their balance sheets by higher rates”. Higher rates will also force the government to cut back on borrowing, ending the easy fiscal policy that has bolstered growth. For The Economist, the recession has been delayed, not cancelled.
Most economists share these concerns but have become more optimistic that the US will avoid a recession. Those surveyed by The Wall Street Journal in October put the probability of a US recession in the next 12 months at 48%, the first time in over a year that the probability has dropped below 50%. The central view for most economists is of weaker, but continuing growth.
Deloitte’s US economist, Danny Bachman, was optimistic on the US earlier this year and has been amply vindicated by events. Danny’s central view now is that US growth will slow slightly next year, from about 2.5% to just under 2.0%.
The US economy faces two opposing forces in 2024. On the one side, the lagged effects of raising interest rates by over 500bp are still feeding through the system. That speaks to higher credit costs, problems for more indebted corporates and consumers, and higher unemployment to come. The opposing force comes in the form of lower inflation that will support spending power and corporate margins.
History shows that soft landings for economies are rare. Major inflationary episodes are classic harbingers of recession. The US has defied that narrative this year. It has a fair chance of doing so next year too.