Last Friday, Jerome Powell delivered some hard truths at the economic policy symposium in Jackson Hole, Wyoming. At Cebr, we have been musing for a while that the US Federal Reserve chairman still harbours some resentment towards his staff given how far off the Fed’s economists were in their assessment of domestic inflationary pressures. In the US, these were initially driven by a strong post-pandemic rebound in demand and fuelled by the various federal stimulus packages.
In his speech, Mr. Powell made it clear that he would not stand by idly to watch prices spiral further out of control and inflation expectations become unanchored. Moreover, he quite bluntly stated that the Fed’s way of reducing aggregate demand in the economy through monetary tightening would likely ‘bring some pain to households and businesses’1, which we can take to understand as rising unemployment and lower profits. Nevertheless, a Fed pivot might come sooner than generally expected given some underappreciated risks to the US economy.
Taking stock of the current situation, it is easy to see that the Fed still has some hard work to do. Although the inflation rate on the Core Personal Consumption Expenditure Index, the Fed’s preferred inflation measure, dropped from 4.8% in June to 4.6% in July and now stands at its lowest level since October 2021, this is still uncomfortably high and well above the 2% target set by the central bank. More rate rises will follow and Cebr expects the next 75 basis point hike to happen in the September meeting with two further 50 basis points increases a strong possibility in November and December.
Based on this assessment, further tightening should be expected in 2023 – but this will depend on the future path of inflation in the US. Indeed, there are signs suggesting that some of the supply chain issues plaguing the global economy are starting to ease. In the meantime, the risk of a deeper US recession continues to rise.
Looking at the Baltic Dry Index, a measure of global shipping costs, there has been a steep downward trend since May this year, brining the index to its lowest levels since the early days of the pandemic in June 2020. Oil looks set to end the year below the $100 per barrel threshold, as Cebr had predicted earlier this year. Meanwhile, US petrol prices have also receded from recent highs, with the national average falling to under $4 per gallon.
While some of the supply constraints for the US economy have started to ease, a deeper-than-expected recession might also help the Fed’s job of bringing demand and supply back into equilibrium. The US economy entered a technical recession in Q2 following two quarters of (barely) negative growth, but more pain is on the cards as the housing market looks set for a sizeable correction. The good news here is that households (and banks) seem to be in a better position than before the 2007-2009 crisis. But a look at the fundamentals is nevertheless worrying, revealing new home sales falling to a six-year low of 511,000 units in July while new housing starts plummeted by 9.6% during the month.2 The demand-supply imbalance in the property market will further widen as borrowing becomes considerably more expensive due to higher interest rates. US consumer spending has held up reasonably well thus far, but a tanking housing market could yet spell trouble for the world’s largest economy given the sector’s importance to both the real and financial side of the economy.
Further downward pressure on growth can be expected from the inventory cycle. During and after the pandemic, US businesses started to build up their inventories in fear of further disruptions to their supply chains and in response to changing consumer behaviour. At its peak earlier this year, wholesale inventories increased by nearly 3% a month, the highest rate on records. Since Q1, this growth rate has slowed considerably to just 0.8% in July and we expect destocking to accelerate towards the end of the year. Businesses with excess stock are likely to slow production temporarily in order to reduce inventories which will weigh on output. Moreover, they are also likely to slash prices to clear out their warehouses faster, which would slow inflation. Mr. Powell ended his speech at Jackson Hole with the promise to ‘keep at it until […] the job is done’. Should a collapsing housing market, deepening US recession and easing supply constraints all coincide in the first half of next year, this job could be finished much sooner than currently expected.
For more information please contact:
Kay Neufeld, Head of Forecasting and Thought Leadership Email firstname.lastname@example.org Phone 020 7324 2841