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Has the US pulled off an economic soft landing?

By the OFX team | 10 Aug 2023 | 5 minute read

US job figures for the month of July have sent a clear message that Federal Reserve Chairman, Jerome Powell, looks to have pulled off one of the toughest jobs in global economics – a soft landing after aggressively hiking interest rates.

The Bureau of Labor Statistics report, released August 4, showed 187,000 jobs were created in July, lower than expected and comfortably at a rate that shows the economy is growing at a measured pace.

While the current unemployment rate of 3.5% is the lowest in decades, wages aren’t spiralling out of control. They are up 4.4% for the year, but that is only a 0.4% growth for the month, and already showing signs of slowing.1

It’s further evidence that the Federal Reserve’s decision to raise rates by a quarter of a per cent on July 27, may be the last.

“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,” Powell said following the board’s two-day meeting.

How to engineer a soft landing

The interest rate decision came on the same day that official US growth figures showed the economy is remaining highly resilient. It grew 2.4% year-on-year in the second quarter, and was up compared to the previous quarter’s 2%.

Consumer spending remains robust, growing at 1.6%, while business investment also grew.2

Businesses are clearly feeling more optimistic – they grew inventories over the quarter3 – a sign they expect consumers to continue buying in the future.

It’s a remarkable turnaround from just a few months ago, when the collapse of Silicon Valley Bank and others sent shockwaves through the US that after 10 straight rate hikes – from 0 to a then 4.75% – fissures had opened up in the financial system. A series of layoffs in the tech industry also contributed to that negative view.

Instead, the recessionary fears have been mostly contained to a few industries, and the tech gloom has well and truly subsided4, with the buzz around artificial intelligence and tech giants delivering big stock market gains.

Conditions are so robust across the board that a recent survey of economists across the business sector showed that the vast majority of them – 71% – now expect the chances of a recession to be 50% or less.5 

“Results of the survey reflect an economy of rising sales and profits, as material costs decline and stabilising wages prove less challenging,” said the National Association of Business Economists, the conductors of the survey.6

Consumers are bullish too, showing the highest level in optimism since September 2021, and the largest month-on-month rise in optimism since 2006.

Why have rate rises not had a larger impact?

With 11 rises in a row, most expected a recession would follow. But two things have been working in the country’s favour.

First, unlike most other countries, the US has long-dated fixed-rate loans. That means that for the majority of mortgagees and a good number of corporates, the interest hikes haven’t resulted in higher payments.

Both groups have instead been using the favourable conditions to pay down debt.

Household debt has dropped from 100% of GDP in 2010 to just over 75%.

Corporate debt has also fallen, down from 105% in 2020 to 82% today.

Even those corporations who have to raise money using so-called “junk bonds” (those with much higher interest) are also enjoying the benefit of cheap money, with the majority of bond repayments not falling due until 2028.7

It means that the impact of servicing debt is not putting as large a crimp in spending as it otherwise would. 

Government spending adding fuel to the economy

The second big factor behind America’s unusually powerful growth story has been the impact of President Joe Biden’s stimulus projects. 

The US government’s infrastructure bill, the Inflation Reduction Act and CHIPS Act, aimed at reshoring manufacturing to boost domestic production of energy-efficient and high-tech industries, is encouraging significant domestic private investment.

According to the President’s Council of Economic Advisers, investment in manufacturing facilities had contributed more than a third of a percentage point to overall G.D.P. growth, the most since the 1980s.8

It’s not just a short-term sugar hit either. Given the programs have years to run, businesses are investing with the certainty of long-term economic activity.9

Govt takes on debt amid private sector deleveraging

In all, the trillions in new stimulus spending has added to a US debt pile that has now hit $32.5 trillion.10 In the last 9 months of the fiscal year alone, the deficit has widened by $1.4 trillion, only part of which came from stimulus spending. The growing debt comes as levels of partisanship in the US Congress over the debt ceiling has worried ratings agencies to such an extent that Fitch Ratings has downgraded the US from its top-tier AAA rating to AA+.11

That’s one of the few clouds hanging over the economy as it leads into an election cycle.

Republicans have traditionally sold themselves as debt hawks, and if President Biden was voted out of office and replaced by Republicans, some of those signature programs might be cut. That won’t be a reality until November next year but expect it to be a feature of the electoral debate.

The other concern is that all this spending has kicked the can down the road in terms of slowing the economy fully. More than that, pessimists suggest that as this spending continues to roll out, it will remain an inflationary force.

That’s the view of Federal Reserve Board member Michelle Bowman who recently told a forum that more hikes would likely be needed to keep inflation in check.

“I will be watching for signs of slowing in consumer spending and signs that labour market conditions are loosening.”12

What that means for currencies

Against a basket of currencies, the US dollar had dropped by 13% from October last year to mid-July as the Federal Reserve has slowed the pace of rates while other nations have also started hiking more aggressively.

But the dollar has ticked up 2.5% in recent weeks as markets absorb the news that the US is delivering strong GDP growth.

That’s partly due to expectations that rates may still be hiked as the economy stays buoyant, but also likely due to a view that better financial returns can be delivered by investing in the US stock market, and lending to US companies. As global financiers send funds to invest in the US, that increases the demand for US dollars.

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