Macro – US

Can the US economy keep defying gravity?

04 December 2023

America continues to resist the downward pull of sky-high inflation and zooming interest rates. It is coming at a cost, notably in the form of stratospheric government spending. In the run up to the next presidential election, the risks of a recession of sorts will likely grow. 

By Julien Lafargue, CFA, London UK, Chief Market Strategist

Please note: All data referenced in this article is sourced from Bloomberg unless otherwise stated, and is accurate at the time of publishing.

The main economic surprise of 2023 was the resilience of the US economy, driven primarily by the government’s fiscal largesse. While growth was much stronger than expected, it has come at a cost. 

The US debt pile surpassed $33 trillion in 2023, up more than $3 trillion during the year and $10 trillion since 2019, the last calendar year before the COVID-19 pandemic. Meanwhile, the latest Congressional Budget Office (CBO) projections point to a budget deficit that will be above 5% of gross domestic product (GDP) for the next ten years. Ouch. 

At this rate, the amount of US government debt could surpass $50 trillion by 2033. This, at a time of higher interest rates (at least for now), could mean that, by 2031, the country spends more on interest payments than it does on non-defence discretionary expenditure (such as funding for transport, education, health, international affairs, natural resources and the environment, and science and technology). This is unsustainable.

Challenging US exceptionalism 

Without a large, price-insensitive buyer like the US Federal Reserve (Fed), and with the apparent desire of foreign central banks to diversify away from US-linked currency or debt holdings, the government can’t afford to spend in a totally reckless fashion. 

This issue will likely be a key point of debate among White House hopefuls in the run up to the presidential election in 2024. Especially at a time when tensions around the debt ceiling and government funding are such hot potatoes. 

Despite the dangers facing the nation’s economy or assets, there is still no credible substitute to the perceived safety offered by the country’s government bonds. Furthermore, many locally based companies still dominate their respective industries globally, in terms of both market share and profitability. 

Yet, with the above headwinds in mind, the US economy is unlikely to generate significant growth in 2024, with real GDP forecast to slow to 1.0% during that year (see table), down from the 2.4% anticipated this year. While hardly exciting, such performance stacks up well compared to European nations.

US economic forecast, year on year (%, F = forecast)

  2022 2023F 2024F
GDP growth 1.9 2.4 1.0
CPI inflation 8.0 4.1 2.6
Unemployment rate 3.6 3.6 4.2
Gross public debt (% of GDP) 122.0 123.2 126.2
Private consumption 2.5 2.2 1.1

Source: Barclays Investment Bank, Barclays Private Bank, November 2023

Inflation to moderate and put a lid on rates?

With consumers running out of the excess savings built up during the pandemic, partly via government spending initiatives, as well as limited real wage growth and the soaring cost of financing debt, consumption will likely falter in 2024. In turn, this would probably limit companies’ ability to hike prices, in turn helping to tame inflationary pressures. At least, that’s the theory. 

In addition, shelter costs should gradually normalise in 2024, pressured by higher interest rates, according to the Federal Reserve Bank of San Francisco1. As a result, barring a major economic shock, domestic inflation should continue to trend lower and possibly dip below 3% in the next 12 months.

Should inflation return to within touching distance of the central bank’s 2% target, this would offer some welcome respite for the Fed; perhaps enough for policymakers to consider cutting rates in the second half of 2024. Of course, this is dependent on a relatively “soft landing” for the economy and a somewhat limited increase in the unemployment rate (forecast to tick up towards 4.5%).  

That said, if the macroeconomic picture worsens faster than anticipated, then the central bank could be forced to act more forcefully. On the other hand, there seems to be little risk of significantly higher domestic interest rates in coming months.

The US economy is unlikely to generate significant growth in 2024, with real GDP forecast to slow to 1.0%. While hardly exciting, such performance stacks up well compared to European nations

Jobs, housing and credit

Looking to the coming year, there appear to be three main risks around the base case. These largely relate to pandemic-related discrepancies that have yet to be resolved.  

The first is the local job market, which has remained incredibly tight in 2023. The persisting strength of the local economy, in the face of several signals of a pending recession, accounts for some of this performance. Another factor might be linked to “labour hoarding”, as companies retain staff by fear of not being able to hire them back when economic prospects turn for the better.

The second risk relates to the impact of higher rates on the domestic housing market. Outside of new builds, activity has been anaemic in the face of soaring mortgage costs and people preferring to stay put rather than move house. While this is technically sustainable, it likely restricts job mobility and with it, potential economic growth. As such, house prices may have to adjust lower, eventually.  

Finally, with the surge in interest rates seen in the last 18 months still working its way through the economy, the credit market is a source of potential concern. Whether it’s more companies defaulting or an uptick in credit card delinquencies, the extent of the hit to the economy is still unclear. However, on balance, credit measures are most likely to deteriorate further in coming months.

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