U.S. economy: recession not yet here, but increasingly likely

Recession, yes or no. That has been the big question for several months now. The economic situation remains very uncertain. It is rightly pointed out, for example, that the labor market is still robust. But the first dark clouds are already gathering on the horizon, even for the labor market. And other indicators, such as the purchasing managers’ indices or the development of gross domestic product in the fourth quarter of 2022, point overall to a significant cooling of the U.S. economy, which could lead to a recession.

In the fourth quarter, the U.S. economy did post solid gains of an annualized 2.9 percent at first glance. However, a large portion was due to higher business inventory accumulation. The winter months also saw a marked decline in purchasing managers’ indexes, and consumer sentiment, while improving somewhat, is still gloomy.

The high level of savings accumulated in the wake of the pandemic is gradually being eroded, and consumer demand will no longer be able to play its role as the main growth driver of the US economy in the same way as before. In 2023, private consumer spending will probably develop in a subdued manner. Against this background, business investment will also develop weakly in 2023. Higher interest rates will also worsen corporate financing conditions.

The threat of a slowdown in growth or even recession in the USA will also increasingly worsen the situation in the labor market. Most recently, the unemployment rate was only 3.4 percent in January. However, many people have withdrawn from the labor market in the wake of the pandemic; the labor force participation rate in January was still lower than before the pandemic in February 2020. I do not expect unemployment to rise dramatically, but it will still increase noticeably during the spring and summer. Wage increases are also lower now.

Monetary policy rapidly tightened during 2022 in the face of increasingly dramatic high inflation. In December, the consumer price index published by the Bureau of Labor Statistics was 6.5 percent higher than in the same month a year earlier. While in 2021, a significant portion of higher inflation 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 much broader range of goods. Inflation is still likely to be noticeably above three percent this year. I do not expect inflation to be near two percent until 2024.

The personal consumption expenditures index published by the Bureau of Economic Analysis, which the U.S. Federal Reserve primarily uses for its monetary policy decisions, will also remain noticeably above the central bank’s average inflation target of two percent in 2023, following a year-on-year increase of 5.0 percent in December. Only in 2024 do I expect a decline to two percent. After all, many commodity prices have reduced sustainably, and the problems in global supply chains are increasingly dissipating. And 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, with the usual lag.

The U.S. Federal Reserve will probably raise its interest rates twice again this year. I expect one more hike of 0.5 percent in March and two further hikes of 0.25 percent before the Fed is likely to pause. Then, starting in the beginning of 2024, I expect slight rate cuts in the face of lower inflation and a weak economy. The U.S. economy will grow by only 0.6 percent this year compared with 2022, with the U.S. economy going through a slight recession for two quarters. In 2024, the U.S. economy will recover only sluggishly in my base scenario, growing by only 0.7 percent.

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