U.S. economy: Surprisingly robust development with inflation still high

Recession, yes or no? Many economists have been pondering this after GDP in the United States shrank somewhat in the first half of the year. It was rightly pointed out that the labor market was robust and domestic demand was solid. The decline in economic output in the first half of 2022 was mainly due to the fact that business inventory building was much less dynamic than towards the end of 2021 and residential investment had recently declined.

The U.S. economy contracted by 0.4 and 0.1 percent quarter-on-quarter in the first and second quarters of 2022, respectively (annualized 1.6 and 0.6 percent). Thus, the economic recovery following the pandemic-related slump in the first half of 2020 did not continue. By the summer of 2021, U.S. economic output had already returned to the level of the final quarter of 2019 before the pandemic – earlier than in most countries in Europe, for example. Most recently, private consumption was still growing at a surprisingly robust pace in the second quarter of 2022, and business investment had not yet declined either.

In the second half of the year, the U.S. economy will continue to face various headwinds from high inflation, subdued growth in the global economy, and rising interest rates. However, the economy is still developing surprisingly robustly despite these many headwinds. I expect only a mild recession, but then only a sluggish recovery in 2023. Purchasing managers’ indices have fallen and, above all, consumer sentiment has plummeted – mainly because of inflation.

The high level of savings accumulated during the pandemic is now being reduced and consumer demand will now no longer be able to play its role as the most important growth driver of the U.S. economy as it has in the past. Over the course of 2022 and 2023, growth in private consumer spending will gradually weaken further. Against this background, business investment will also develop weakly in the second half of 2022. Higher interest rates are also rapidly worsening corporate financing conditions.

The dynamic recovery of the U.S. economy has also steadily improved the situation on the labor market. The unemployment rate in July was only 3.5 percent and 3.7 percent in August (due to higher labor force participation), down from 4.7 percent in September 2021 and 14.7 percent in April 2020. However, in the wake of the pandemic, many people withdrew from the labor market, at least temporarily; the labor force participation rate in August was still around one percentage point lower than before the pandemic in February 2020. The labor market situation is now unlikely to improve further. Initially, the number of job vacancies will probably decrease. For the moment, there is no reason to fear a significant rise in unemployment. Wage increases will now probably be lower and lead to losses in inflation-adjusted wages for many people.

Monetary policy is now rapidly becoming more restrictive in view of the still dramatically high inflation. In July, the consumer price index published by the Bureau of Labor Statistics was 8.5 percent higher than in the same month a year earlier. While much of the higher inflation in 2021 was still attributable to temporary factors such as higher oil prices, as well as supply shortages and associated price increases for various goods – such as semiconductors and raw materials – higher price increases are now evident across a broader range of goods.

I think that inflation will decrease somewhat faster than others. However, inflation will probably remain above two percent in the coming year. The personal consumption expenditures price index published by the Bureau of Economic Analysis, which the Federal Reserve primarily uses in making monetary policy decisions, is also expected to be very significantly above the central bank’s average inflation target of two percent in 2022, following a 6.8 percent year-over-year increase in July. Even in 2023, I still do not expect a decline to two percent. However, many commodity prices seem to have reduced sustainably and the problems in global supply chains are gradually dissipating. Thus, inflation pressures will gradually decrease. In addition, consumer demand in the U.S., which was strong until recently, is gradually becoming less dynamic, further reducing inflationary pressures. Interest rate hikes by the U.S. Federal Reserve are also likely to dampen inflation significantly in the coming months.

Against this background, the Federal Reserve is likely to raise interest rates significantly by the end of the year. I expect an overall increase of 1.5 percent. After that, I expect the central bank to leave interest rates at a high level until the end of 2023. I then expect slight interest rate cuts in 2024. In one scenario, however, I assume that the central bank will even overshoot in its fight against inflation at present and will reduce its interest rates again as early as the summer of 2023.

All in all, the U.S. economy is likely to grow by only 1.5 percent in the current year compared with 2021. In 2023, the growth rate will decline further to 0.5 percent before a recovery sets in in 2024 and the economy will grow by 2.1 percent, albeit still at a subdued pace. 

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