The Fed raising its forecast for economic growth by the end of this year shows this agency's confidence in the soft-landing possibility despite the aggressive and hawkish interest rate hiking process throughout the past year. Even, quite a few “figures” believe the Fed can achieve this soft-landing goal..., typically the Goldman Sachs economist:
However, Viet Hustler maintains the assessment from last week's macroeconomics article and believes it's still too early for the Fed to celebrate the soft-landing possibility. Especially when the impact of the credit crunch situation on businesses remains an unknown. Because the effects of the high interest rate policy took 1 year to impact the banking crisis at the present time, the current credit crunch will also need a similar time period to start affecting businesses, the labor market, savings, and consumption.
In this week's macroeconomics article, Viet Hustler will discuss the soft-landing possibility from the Fed's view and from the neutral view of economic data that may have been “overlooked” by the Fed.
What causes the Fed to be confident about the soft-landing possibility?
Strong consumer spending by Americans and a highly promising labor market could be the 2 main reasons making the Fed hope for the soft-landing possibility!
Nearly 70% of current US GDP comes from consumer spending:
Recall: Q1/2023 GDP growth was still mainly driven by consumer strength. (Green column)
Retail sales in 2022 and early 2023 still grew quite impressively:
US nominal retail sales have increased from: USD 450 billion pre-pandemic => up to USD 599 billion now.
This figure is +15% higher than the forecast based on the pre-Covid trend and +30% higher than the pre-pandemic figure.
For the labor market, high labor demand from businesses has kept the labor market quite resilient throughout the past year
Record low unemployment rate in April this year (3.4%), though it has risen slightly in May to 3.7%.
Payroll numbers still rising high (light green) while hiring activity in manufacturing firms remains brisk - still increasing from the end of last year (black chart line).
When people still have jobs, businesses are still operating and hiring, and most importantly consumer strength remains... the Fed remains confident that GDP, even if weakening due to slowing demand (the main purpose of the Fed's high interest rate policy), will still grow (GDP growth > 0%).
Along with confidence in the labor market and consumption, the still high core CPI could continue to push the Fed to raise rates from now until year-end.
US inflation fell in May to +4% y/y - the slowest pace since March 2021. However, Core CPI remains quite high at +5.3%.
Especially core CPI for goods is trending upward again (light green chart line) while core CPI for services has slowed.
The post-FOMC dot-plot of members also suggests there may be 2 more rate hikes from the Fed by year-end to curb inflation.
Related article: Fed's direction after June FOMC.
However, as mentioned above, Viet Hustler believes the Fed's confidence in soft-landing is still too early!
Even, this soft-landing confidence may come at the cost of a financial system collapse due to pressure from the previous overly hasty rate hiking process.
Why the Fed may not achieve soft-landing?
Of course, the Fed is correct that overall consumer strength and labor market will be the main factors determining whether a recession occurs or not, or the shallow or deep extent of the recession (if any).
However, the consumption and labor indicators the Fed is relying on only deteriorate markedly once a recession occurs. Meanwhile, some indicators that do not directly impact these 2 factors of consumption and labor are precisely the leading indicators signaling cracks in these 2 factors.
Regarding consumption
The rapid consumption increase in the recent period may be due to 3 economic stimulus packages over the 2 Covid years (2020-2021). However, the impact from this relief money is gradually fading.
Savings peaked after the first economic stimulus package (April 2020), then continuously declined rapidly to sustain spending throughout the inflation period.
Currently, total US household savings has fallen back below < USD 1000 billion, signaling spending will slow in the second half of 2023.
Meanwhile, US household savings is much lower than the pre-pandemic trend forecast:
deficit ~ -USD 1270 billion vs. pre-Covid trend forecast.
The recent retail sales increase came at the expense of the savings rate hitting bottom in Q3/2022.
However, retail sales growth has shown signs of slowing. Even dropping to negative (-3.26%) after inflation adjustment.
House selling prices have fallen to an unprecedented record low: -8.9% q/q in Q1/2023, the largest decline ever.
… indicating that home buying demand from the public has declined, as the public's ability to afford large expenses has become limited.
In addition, most Americans will have to resume student debt payments by the end of this year. This means spending will be significantly curtailed.
Total student debt has reached ~USD 1.8 trillion, accounting for about 10% of the US national debt.
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Labor Market
Viet Hustler has emphasized many times that labor statistics are quite lagging indicators relative to the health of the economy. Unemployment only truly rises at the end of a recession cycle when a series of businesses go bankrupt and lay off employees.
To gauge the upcoming labor market situation, one must rely on the current health of businesses (the employers).
The National Activity Index from Chicago Fed fell in May to -0.15 (from a favorable +0.14 in April/2023).
Among them, indicators measuring production activity and employment hiring are both negative, showing a clear slowdown in business activity
… and will impact the upcoming labor market.
Last week, bank commercial loans fell -USD 40.6 billion, the second largest decline since the 2008 Financial Crisis.
Credit crunch will also force businesses to cut back on production due to a shortage of funding.
Currently, the first crack in the labor market is that wage growth and hours worked have declined, indicating that labor demand from businesses has cooled.
Geopolitical impacts on the economy
Earlier this year, Bank of America, BlackRock, and Citibank… all emphasized geopolitical risks and their impact on the market.
Although not the main cause of inflation, the war between Ukraine and Russia contributed to pushing inflation to a peak last year, especially for Europe.
This weekend, the possibility of a coup in Russia raised hopes that the war would end. However, this event ended quite quickly. (update on Facebook Page of Viet Hustler.)
If the Russia-Ukraine war could end, primarily Europe's inflation situation would improve because Europe's inflation was heavily affected by surging energy and food prices after the war. In the US, inflation would not be directly affected.
However, the US would benefit from lower European import prices, which would also help ease US inflation.
Before Covid, the US always ran a goods trade deficit with Europe.
However, the possibility of Russia continuing to supply energy to Europe would cause the US to lose an important customer:
LNG liquefied natural gas imported from the US is one of the alternative energy sources for Europe to avoid dependence on Russia.
If the war on the other side of the Atlantic ends, reduced US exports to Europe will also affect the Fed's “hope” for soft-landing.
In addition, US-China relations remain an economic barrier for both countries.
Related article: China's post-reopening economy and the impact of geopolitical risks.
Restricting US Venture Capital investments into the billion-population market with numerous promising startups in China will cause the US to lose a source of foreign exchange revenue.
Although this revenue source may not be as important as national security, the shortfall from these revenues will contribute to reducing the US's Gross National Income (GNI) and Gross National Product (GNP).
CONCLUSION
The Fed may still be relying on the strength of US consumer spending (70% of GDP) and the resilience of the labor market to predict a soft-landing by the end of this year. This is completely reasonable. However, the data the Fed is focusing on are somewhat more lagging than the changes in the market.
Because only when a recession occurs do both consumption and labor variables change simultaneously: unemployment surges due to business bankruptcies and mass layoffs + consumers tighten their belts in spending due to rising unemployment.
Of course, when both sharp declines in consumption and rapid rises in unemployment occur simultaneously, the Fed will achieve its inflation control goal, but there will be no soft-landing.
The strength in US consumer spending over the past year has largely been based on economic stimulus packages during the Covid pandemic and the trade-off of increasingly eroded savings rates. Soon, people will continue paying student debt with depleted savings accounts. At that point, can consumption still shoulder US GDP growth?
The labor market should not be gauged by an ex-post indicator like the current unemployment rate, but should be assessed based on ex-ante data used to predict business health. Meanwhile, the impact of the Credit Crunch on businesses remains unresolved.
Finally, although the short-lived attack by the Wagner mercenary company on Russia could not stop the Russia-Ukraine war, sooner or later, this war will end. At that time, US energy exports will be affected, further limiting US economic growth. In particular, tense US-China relations also limit US revenue from the billion-population market. These geopolitical risks could significantly impact the Fed's soft-landing hopes in the 2023-2024 period ahead.
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