AMSCI Newsletter July August 2023

The U.S. economy expanded at a faster clip than had been expected in the second quarter, growing at an annualized rate of 2.4 percent even amid elevated inflation and rising interest rates.

The Bureau of Economic Analysis reported that the increase in gross domestic product (GDP) “reflected increases in consumer spending, nonresidential fixed investment, state and local government spending, private inventory investment, and federal government spending that were partly offset by decreases in exports and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, decreased.”

The economy grew at a 2 percent rate during the first quarter.

Year-over-year inflation has declined each month since June 2022, when it hit 9.1 percent, which has, perhaps, encouraged spending and economic expansion. During Q2, inflation was at 4.9 percent in April, 4.1 percent in May and 3 percent in June.

The most recent reading is, for the first time since early 2021, nearing the Federal Reserve’s target inflation rate of 2 percent. Notwithstanding the announcement by the Bureau of Labor Statistics of the sharply reduced inflation rate on July 12, the Fed two weeks later increased interest rates another quarter-point to put the target range for the Federal Funds Rate at 5.25 to 5.5 percent. A month earlier, the central bank had kept rates unchanged after increasing them at 10 consecutive meetings.

“Recent indicators suggest that economic activity has been expanding at a moderate pace,” the Federal Reserve said in announcing the July increase. “Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated. The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain.”

The Fed may have been emboldened to return to aggressive action against inflation by optimistic revisions that its staff made to economic projections. Federal Reserve Chair Jerome Powell said following the rate hike announcement that “the staff now has a noticeable slowdown in growth starting later this year in the forecast, but given the resilience of the economy recently, they are no longer forecasting a recession.”

Some other analysts also see the “soft landing” for the economy that Powell and the Fed have sought as becoming more likely. CNBC reported that Goldman Sachs, for example, has reduced what it sees as the likelihood of a recession within the next year to 20 percent, with the firm’s chief economist stating in a report that “recent data have reinforced our confidence that bringing inflation down to an acceptable level will not require a recession.” Similarly, Bank of America, also according to CNBC, stated in a recent report, “What’s out: Mild recession. What’s in: Soft landing, no recession.”

Recession predictions have become harder to maintain with job growth continuing to be healthy each month and the unemployment hovering around the lowest it has been since 1969. In July, according to the Bureau of Labor Statistics, the economy added 187,000 jobs – with especially notable gains in health care, social assistance, financial activities and wholesale trade – putting the unemployment rate at 3.5 percent.

An additional wild card that could affect the nation’s economy is the move by Fitch on Aug. 1 to downgrade the United States’ credit rating from AAA (the highest rating) to AA+ because of “a steady deterioration in standards of governance over the last 20 years.” Recent events contributing to the decision, according to CNN, included this year’s debt ceiling brinkmanship and the Jan. 6, 2021, storming of the U.S. Capitol that interrupted Congress’ certification of the 2020 presidential vote results from the Electoral College.

Treasury Secretary Janet Yellen criticized the downgrade, saying it is “arbitrary and based on outdated data.”

Stocks fell for three straight days following Fitch’s announcement, with the Dow Jones Industrial Average closing at 35,065.62 on Aug. 4, up 5.8 percent on the year. The S&P 500 Index ended Aug. 4 at 4,478.03, for a year-to-date gain of 16.6 percent.

The dollar, at least in the short term, appeared to be largely unaffected by the downgrade. On Aug. 4, it was trading at 0.91 euros, 0.78 pounds, 141.79 yen and 7.17 yuan, very close to the exchange rates on the day before the announcement.

High interest rates continue to discourage existing home sales, with sales dipping 3.3 percent from May to June, and year-over-year sales falling 18.9 percent, according to the National Association of Realtors.

“The first half of the year was a downer for sure with sales lower by 23 percent,” the association’s chief economist said. “Fewer Americans were on the move despite the usual life-changing circumstances. The pent-up demand will surely be realized soon, especially if mortgage rates and inventory move favorably.”

Housing starts, meanwhile, dipped 8 percent from May to June and were down 8.1 percent from a year earlier, the Census Bureau and the Department of Housing and Urban Development reported.

Confidence in the manufacturing sector has increased slightly but it remains low. The Institute for Supply Management’s Purchasing Managers Index in July recorded its first gain in three months, but it is still below the thresholds indicating growth in the sector and expansion in the overall economy.

Only two of the 16 industries surveyed reported growth in July: petroleum & coal products and furniture & related products.

“Demand remains weak but marginally better compared to June, production slowed due to lack of work, and suppliers continue to have capacity,” the chair of the institute’s Manufacturing Business Survey Committee said. “There are signs of more employment reduction actions in the near term to better match production output.

Consumer confidence, however, showed big gains in July. The Index of Consumer Sentiment from the University of Michigan Surveys of Consumers improved by 11.2 percent from June and by 39 percent from July 2022. The surveys director said the improvements are “largely attributable to the continued slowdown in inflation along with stability in labor markets.”

The Conference Board’s Consumer Confidence Index, meanwhile, went up by more than 6 percent to reach its highest level since July 2021.

“Expectations for the next six months improved materially, reflecting greater confidence about future business conditions and job availability,” the organization’s chief economist said. “This likely reveals consumers’ belief that labor market conditions will remain favorable.”

With consumer spending accounting for about 70 percent of the nation’s economic activity, it is likely that pent-up demand that accumulated from 2020 to 2022 is significantly contributing to the economy’s resilience. When that softens, though, the economy could be more vulnerable to other factors, such as the war in Europe, continued interest rate increases by the Federal Reserve, potential unrest related to the 2024 presidential election, and any number of events in China.