The resilience of the US economy is reflected in the fact that the recession under the pressure of high inflation and monetary policy tightening has not arrived as expected, and the space for economic "soft landing" has opened. The main reasons include: first, fiscal stimulus has ensured the relative health of the balance sheets of US households and businesses; Second, the U.S. economy slows or even declines in some areas, but not in all sectors at the same time; Third, the Fed's monetary policy is not excessively restrictive and has a time lag effect. According to the latest estimates from the Atlanta Fed, the annual depreciation rate of U.S. GDP in the third quarter of 2023 may be as high as 5.8%. In the short term, the U.S. economy will remain resilient and may even be stronger than expected. However, the slow downward pace of core inflation has forced the Fed to maintain monetary policy tightening, and downside risks to the US economy remain a concern.
After suffering from high inflation and continued interest rate hikes, the economy in the United States has not fallen into the widely expected recession, but has stabilized at a relatively high growth level. The market's judgment on the outlook for the US economy has also shifted from a "hard landing" to a "soft landing" or even a "no landing". We need to objectively see that the macroeconomic policy of the United States has indeed played a positive role in coping with the impact of the crisis, providing key momentum for the recovery and sustained growth of the US economy, and also providing policy experience for crisis response and management in other countries. Of course, this does not mean that the risk of recession in the United States has been lifted, and the most critical core inflation has shown strong stickiness, which forces monetary policy to continue to tighten, and the downside risk to the economy remains large. Performance of U.S. Economic Resilience Resilience generally refers to an economy's ability to avoid shocks, withstand them, and recover quickly and regain steady economic growth after suffering shocks. The resilience of the US economy beyond expectations is mainly manifested in two aspects. First, the US recession did not come as expected. Historically, there has never been a precedent for the United States to successfully manage inflation without triggering a recession. In the 70s and 80s of the 20th century, in order to curb inflation, the Fed raised interest rates four times, all of which triggered a recession. In March 2022, the US CPI growth rate rose to 8.5% year-on-year, and the Fed was forced to start the current cycle of interest rate hikes. Under the pressure of high inflation and tightening monetary policy, US GDP fell into a "technical" recession in Q1 and Q2 2022 at an annualized rate of -1.6% and -0.6%, respectively. However, from Q3 2022 to Q2 2023, with US GDP depreciated at 3.2%, 2.6%, 2.0% and 2.4% annualized respectively, the US appears to have emerged from the shadow of a "technical" recession and returned to positive growth (Figure 1).
Second, the space for a "soft landing" of the US economy has been opened. For the whole year of 2022, the US CPI grew by 8.0% year-on-year, and the unemployment rate was as low as 3.6%. Historically, it has been difficult for the Fed to reduce inflation without significantly increasing the unemployment rate. However, in July 2023, the year-on-year growth rate of US CPI has fallen to 3.2%, while the unemployment rate has remained low at 3.5%, and the US economy seems to be moving towards a "soft landing" or even "no landing". Second, the reason for the resilience of the US economy The US economy has shown strong resilience, which is the result of a combination of factors. The emergence of new factors and their underestimation are important reasons why the resilience of the US economy has exceeded consensus expectations. The new factor mainly refers to the unprecedented fiscal stimulus policy of more than $5 trillion implemented by the US government in response to the new crown epidemic, and a large part of it is directly distributed to individuals, which has had a profound impact on the shape of the US economic recovery. First, fiscal stimulus has ensured a relatively healthy balance sheet for U.S. households and businesses, allowing the U.S. economy to get back on track quickly after the coronavirus shock. The pandemic was essentially a "blizzard" rather than a traditional recession, but the impact was longer than expected due to the virus mutating and straining supply chains. The U.S. response strategy is to try to keep household and business balance sheets from deteriorating through bailout policies, so that they can survive the "blizzard" smoothly and quickly resume life and production after the storm. From the perspective of policy effects, the leverage ratio of US households and enterprises has remained basically stable, and the main cost is that the government's leverage ratio has increased significantly. As of the fourth quarter of 2022, the leverage ratios of the US residential sector, non-financial corporate sector and government sector were 74.4%, 78.1% and 111.9%, respectively, a change of -0.9 percentage points, 1.8 percentage points and 12.1 percentage points compared with the fourth quarter of 2019. This allowed U.S. households and businesses to get back on track quickly after months of shutdowns and other restrictions, avoiding the lengthy process of repairing their balance sheets. Notably, while fiscal stimulus is generally less in emerging market countries, leverage in their governments has also increased by 10 percentage points compared to pre-pandemic levels. From this point of view, the fiscal stimulus policy in the United States has better achieved economic recovery and growth at a similar cost of government debt, and the macroeconomic policy has been relatively successful. Second, the U.S. economy slows or even declines in some areas, but not in all sectors at the same time. Supply chain tensions, high inflation, and rising interest rates did have a clear impact on the U.S. economy, but other factors provided important support to the U.S. economy, allowing the U.S. to avoid a significant decline in economic activity in many areas at the same time. Specifically, first, in the second and third quarters of 2022, the sharp decline in real estate investment in the United States and the start of destocking by enterprises led to a drag on investment to economic growth, and private sector investment dragged down the US GDP by 2.8 percentage points and 1.8 percentage points respectively. However, consumption remained strong, driving US GDP by 1.4 percentage points and 1.5 percentage points annualized, respectively (Figure 1). Second, since November 2022, the US manufacturing PMI has been below the 50-boom line for eight consecutive months, and the manufacturing industry has continued to shrink. However, during this period, the US services PMI was above the 50-rise line for seven months, and service consumption supported economic growth. Taken together, strong consumer demand is an important reason why the U.S. economy has not experienced a recession. In the process of the Fed's continuous interest rate hikes, the reason why the consumption of the US residential sector can remain strong for a long time is mainly because the bailout policy implemented by the US government in the early stage of the epidemic has caused the residential sector to generate a total of about $2.4 trillion in excess savings. This part of excess savings not only supports the consumption of US residents, but also drives the consumption structure of the United States to shift from durable goods to non-durable goods and then to services, so that the US economy will not lose growth momentum in all sectors at the same time. At the same time, strong consumer demand leads to increased employment, which in turn stimulates consumption, ultimately creating a virtuous circle for the economy. Third, the Fed's monetary policy is not excessively restrictive and has a time lag effect. First, from the perspective of various indicators, the Fed's monetary policy is only moderately tightened. Although the Fed embarked on the fastest sustained rate hike in nearly four decades, monetary policy tightening could not be compared to the "Volcker era" of the early 80s of the 20th century, and real interest rates only turned positive for the first time in May 2023. The Chicago Fed's adjusted national index of financial conditions stood at -0.31 for the week ended July 28, 2023, indicating that current financial conditions in the United States remain relatively accommodative compared to historical averages. Second, the role of monetary policy has a time lag effect, and the impact of the Fed's interest rate hike has not been fully transmitted to the real economy. Research evidence suggests that the lagged effect of the Fed's monetary policy could be between 12 and 24 months. The starting point of the current Fed rate hike cycle is March 2022, which means that the impact of the Fed's rate hike on the real economy is only beginning to be felt, especially the shorter time for interest rates to reach "restrictive" levels. Third, the credit environment in the United States has changed, and the impact of interest rate hikes on the residential sector tends to weaken. Historically, each Fed rate hike has significantly raised borrowing costs, which in turn has dampened household spending. Today, however, U.S. households are significantly less sensitive to rising interest rates. In the case of mortgages, for example, before the 2008 financial crisis, interest rates were variable for nearly 40 percent of mortgages, and that percentage has now fallen to about 10 percent. This means that the Fed's interest rate hike has no significant impact on previously issued long-term mortgages, and thus less on household spending. Third, the downside risk of the US economy cannot be ignored whether the US economy can eventually achieve a "soft landing", the key is whether it can maintain the unemployment rate without a significant increase, and the core inflation will decline significantly. But there is no indication that this key factor is emerging. The risk of a Fed monetary policy mistake in the future will rise, and considering that the Fed will maintain high interest rates for a period of time, more potential risks may be exposed, which will drag down the US economy. Overall inflationary pressures in the United States have eased, but core inflation risks remain large. From the perspective of inflation sources, supply shortages and strong demand have jointly pushed up inflation in the United States, but the relative importance of supply and demand varies significantly at different times. In the early days of the pandemic, supply chain tensions and even disruptions were the main factors supporting inflation; Since mid-2021, strong demand has gradually become the main driving force for the upward movement of inflation in the United States. With the easing of supply chain constraints and high base effects, the overall inflation rate in the United States has fallen rapidly, but the continued labor force has led to a slow downward rate of core inflation. In July 2023, the US CPI rose 3.2% year-on-year, which is significantly lower than the peak in June 2022, indicating a significant easing of overall inflationary pressures in the United States. But at the same time, in July 2023, the US core CPI rose by 4.7% year-on-year, showing strong stickiness (Figure 2). The U.S. unemployment rate remains low, but employment and core inflation are hard to do. According to the Phillips curve, unemployment and inflation are substitutes for each other, and low unemployment and low inflation cannot coexist. Since the 2008 financial crisis, the Phillips curve in the United States has flattened significantly, the unemployment rate has fluctuated sharply, and the inflation rate has remained relatively stable. This means that a decline in inflation may require a greater increase in unemployment. However, while inflation in the United States has fallen significantly, the unemployment rate has been able to remain low. Why this change? In addition to the exogenous factors mentioned above that the supply-side repair has led to a downward trend in the overall inflation rate, there have also been structural changes in the US labor market. The continued shortage of supply and demand in the US labor market have led to a consistently low unemployment rate. At the same time, the slow decline in job vacancies drove wage growth down at a similar pace, which in turn drove core inflation down slowly (Figure 2). In the future, the supply side of the US labor market is difficult to improve significantly, and the downside of the job vacancy rate is gradually narrowing, and it may only rely on a significant increase in the unemployment rate to promote a significant decline in wage growth and core inflation.
The downside risks to the U.S. economy remain large. First, there is a possibility that the Fed will make a mistake in monetary policy. At present, the overall inflation in the United States has fallen significantly, but the labor market is still tight, core inflation shows strong stickiness, and there is still greater uncertainty about the future inflation trend. Coupled with the time-lagging effect of monetary policy, it is difficult for the Fed to predict the full impact of the tightening monetary policy it has implemented on inflation. If the Fed eases monetary policy too early, it could lead to more stubborn core inflation and another upward movement in inflation. If the Fed eases monetary policy too late, it could lead to an unnecessary recession in the economy. Second, as more households choose fixed-rate loans, the "losses" caused by the Fed's interest rate hikes are mainly borne by commercial banks, but this also means that the risks of the banking industry have increased. If the Fed maintains high interest rates for a long time, the US banking crisis may resume, especially small and medium-sized banks that issue a large number of mortgages with fixed interest rates may be in trouble, which in turn will drag down the economy.
(This article was published in China Forex, Issue 16, 2023.) ）
The cover and the images in the article are from the Internet