How Long Can The U.S. Economy Hold Out?

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Good morning,

The flurry of headlines related to the economy can be difficult to make sense of: Are we in a recession? Will prices continue to rise? Where should I invest my money?

In this new quarterly series, we’ll break down what you need to know about the state of the U.S. economy, and where it’s going next.

We’ll start by zooming out, and taking you through the big indicators. Then we’ll get into a few conversations with real people on the ground, before we check in with economists for their take.

THE BIG DATA: A MIXED BAG

Covid-19 disrupted supply chains and led to soaring inflation. The Federal Reserve embarked on an aggressive campaign beginning about a year and a half ago to combat that, significantly raising interest rates.

Debt is now much more expensive: The average 30-year fixed mortgage rate surpassed 7% in August, reaching its highest level in 21 years.

A rule of thumb definition for a recession is two consecutive quarters of declining GDP, which did occur last year. Another key indicator is an inverted yield curve, when short-term rates are higher than long-term ones, which has been the case since 2022.

Yet, the economy has remained more resilient than expected. Gross Domestic Product, or GDP, grew faster than anticipated in the second quarter at 2.1%, the fourth consecutive quarter of growth. Third quarter GDP data won’t be out until later this month, but forecasters surveyed by the Federal Reserve Bank of Philadelphia predict higher output for the next three quarters than they did previously.

Looking at the labor market, the unemployment rate is historically low at 3.8%, but hiring seems to be decelerating. U.S. employers added 187,000 jobs in August, well below the average monthly gain of 271,000 over the prior 12 months, per the Bureau of Labor Statistics. September’s figures will be released Friday.

And the stock market? Markets are starting to falter after a strong first half of the year as investors are wary about high interest rates. The end of summer marked a cool stretch for stocks, with the Dow Jones Industrial Average flat, the S&P 500 down 1% and the tech-heavy Nasdaq falling 2%.

Still, the S&P 500 is up 11% in 2023 as of the end of the day Thursday, the Dow is down a slight 0.05% and the AI boom has fueled the Nasdaq’s 27% gains this year, not including reinvested dividends.

Inflation remains stubbornly above the Fed’s target of 2%, and consumer prices rose 3.7% in the 12-month period ending in August. It was the largest monthly increase since January, driven by surging gas prices, though far below the 8.3% mark seen a year ago.

Though one key metric came in at its lowest level in nearly two years: core inflation, which excludes the more fickle food and energy indexes, was 4.3% in August.

INFLATION COOLS, BUT WORKERS AREN’T CAUGHT UP

Take Jamie Tillman, for instance. She had been homeless since she was 18, but in March 2020, her faith guided her to The Dream Center, a transitional housing facility in Jackson, Tennessee for women and their children who are experiencing homelessness. “In the meantime, I’m paying off debt, I’m going to work, I’m going to church, rebuilding my life with my kids,” she says.

In the three-plus years since then, she’s worked to pay off much of her roughly $30,000 in credit card debt and improve her credit score.

Tillman was initially earning just $2.13 per hour in a tipped job, making that goal nearly impossible. She eventually landed in a role that pays $12.50 per hour, but even still, paying off the debt on her income has required sacrifices, some big and some small.

With higher gas prices, she’s only making essential trips to work and to drop off her 3-year-old son at daycare. She tries to see her mother and two daughters who live three hours away once a month, but she has to be careful because she drives an older car, and doesn’t want a repair to set her goals off-track.

On a recent Saturday, Tillman and her son wanted to grab their favorite ice cream at the grocery store, but it was almost $9. So they had to settle for a cheaper brand.

When inflation began to skyrocket last year, many like Tillman could no longer keep up. The cost of everyday purchases, from groceries to rent, took up a larger chunk of what workers were earning. In the spring of 2021, the consumer price index started to grow faster year-over-year than wages.

CONSUMER SENTIMENT

As a welcome relief, inflation has slowed recently, and in May, wage growth started to outpace inflation for the first time in years. But the gap isn’t expected to close until sometime in the fourth quarter of next year, Bankrate reports.

Plus, that momentum could be slowing as the labor market cools with Federal Reserve action. From July to August, real average hourly earnings increased just 0.2 percent, its slowest growth rate since the beginning of 2022, the New York Times reports.

Despite all of that, Americans are still opening their wallets. Consumer spending, which represents about two-thirds of economic activity in the U.S., rose 0.4% in August, after July’s 0.9% increase which was the largest in six months.

But some warning signs are flashing red.

Consumer sentiment, while higher than the historic low at the peak of inflation last summer, fell 2% in September, a survey from the University of Michigan found.

Prices at the pump are part of what’s keeping inflation persistent. Oil prices reached a 2023 peak last month, before declining in late September and the early days of October. The average price for a gallon of gas is about $3.72, according to GasBuddy, though it has steadily fallen the last few weeks after hitting an 11-month high on September 15.

The global nonprofit network United Way supports 211, a phone line that connects millions of people in need with local resources like food assistance programs and support for housing. The nonprofit says 211 calls reached their highest level in August, a majority of which were for utility payment assistance and housing related requests.

Marina Gutierrez, communications coordinator for United Way’s Santa Barbara branch, says more of the thousands of families the organization helps are living right on the edge in terms of finances. One unexpected expense like a car repair or even a new pair of glasses throws everything off.

“It’s not just inflation, it’s also just devastated household financial foundations over the last two years,” she says. “And now it’s not going to get any better without pretty significant intervention.”

Consumers nationwide were expected to spend the last of their pandemic savings in the third quarter. Compounding that, household debt is on the rise, and high interest rates mean larger credit card balances. Credit card debt topped $1 trillion for the first time on record, according to a survey from the Federal Reserve Bank of New York.

Plus, borrowers have the added pain of student loan payments coming due this month. Oxford Economics estimates that the resumption will result in a roughly $105 billion reduction in consumer spending.

All of that leads some economists to wonder: Are clouds on the horizon?

THE BIG QUESTION

Is The U.S. Still Headed Toward A Recession?

TOPLINE By many economists’ predictions earlier this year, the U.S. seemed headed toward a recession by the end of 2023. The Federal Reserve was quickly hiking interest rates to combat inflation, and the financial system was strained by the failures of First Republic, Signature and Silicon Valley Banks.

Now, economists are split over whether there’s a recession coming this year or next, or if the Fed can execute what’s known as a “soft landing”—where it brings down inflation to its 2% target without inducing a recession.

Goldman Sachs cut its forecast of a recession in the next year to 15% in a September report because of continued positive inflation and labor market news. Brett House, a professor of professional practice in economics at Columbia Business School, places the odds that the U.S. avoids a recession at 60%.

Economic growth, while slowing, is better than expected. Besides, House says, those gains were eye-popping in 2021 and 2022 as the economy came roaring back from the pandemic.

“We are returning to something closer to normal now,” he says.

The economy’s reopening after the pandemic unleashed pent up demand for goods, and then, it shifted to services: dining out and events like Taylor Swift and Beyoncé concerts.

When the phenomenon known as “revenge spending” is over—and Jeffrey Roach, Chief Economist for LPL Financial, believes an uptick in delinquencies and defaults and dwindling savings are signs it could be soon—that’s when we’ll likely see a small recession. He believes it could still be this year or at the beginning of 2024.

WHAT’S NEXT On the one hand, the Federal Reserve’s tightening worked: Inflation has come down much closer to its target. But the economy’s resilience has surprised policymakers, and the Fed staff increased projections for GDP growth and decreased their outlook for the unemployment rate.

The good news is, rates may not climb much higher. The central bank kept the federal funds rate unchanged in its September meeting, though there could be another increase in November (the futures market currently prices in a 19.6% chance of a hike in November, according to CME Group data as of Thursday afternoon).

The downside of the economy’s strength is we are likely to see rates remain higher for longer than previously expected. That news has roiled markets, and the Dow Jones Industrial Average had its worst day since March on September 26. Those on both sides of the equation agree that whether there’s a recession hinges mostly on the consumer. “I think we’ll have a recession when the consumer says, ‘Okay, I’m done,’” Roach says.

STRATEGY AND SUCCESS

Here are some helpful tips to make the current economy work for you:

12 Ways To Beat Inflation With Your Portfolio

Billionaire Stocks For An October Market Rebound

Inflation Insurance For Retirees: What Does It Cost?

What High Inflation Will Do To Your Bonds And Your Bank Stocks

The Great Yield Chase: Why A Trillion Has Fled Traditional Bank Accounts

QUIZ

We’ve gone over many of the indicators that economists track, like consumer spending and inflation, but there are some more unusual ones too. Which of the following indexes are believed to be indicators of where the economy is headed?

A. Skyscraper construction

B. Men’s underwear

C. Lipstick

D. All of the above

Check your answer.

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And before you go, read our tribute to senior Forbes contributor Gordon Kelly, one of the contributor network’s longest-standing members who tragically passed away on October 1.