Fears of an Imminent Recession Appear Overstated, for Now

Article originally posted on CoStar on August 14, 2024

The combination of the Bank of Japan raising its policy interest rate, a weak U.S. jobs report showing higher unemployment and a downturn in a widely followed manufacturing survey spooked investors and brought chaos to markets last week.

These developments introduced a degree of anxiety and uncertainty and generated new fear in investors and economists of a pending recession. But after a few days of reflection and with a fuller understanding of what transpired, those fears now seem premature.

Oxford Economics, an economic advisory firm, raised its forecast of economic growth for this year, even after the market turmoil. It now projects the economy to grow 2.6% this year, better than the 2.3% it had previously estimated, as initial readings of second-quarter growth came in far better than expected. It added 0.1 percentage points to its forecast of economic growth in 2025, to 1.9%.

The firm cited a stronger forecast for business investment in equipment, which grew by 10.6% (on a seasonally adjusted annual rate) in the year’s second quarter. Firms have been turning toward buying equipment and away from investments in structures that were incentivized by the provisions of the federal CHIPS and Science Act and the Inflation Reduction Act.

Oxford Economics has not been alone in upgrading its forecasts. Consensus forecasts, derived from almost 50 economic forecasters, have been ratcheting higher since early 2023 as data have come in better than expected.

Many economists had been predicting the economy would fall into recession sometime this year after the Federal Reserve initiated its monetary tightening program. Consensus estimates in the second quarter of 2023 for 2024 annual gross domestic product growth were 1.2%. But as the economy surged through the second half of the year, consensus projections moved higher, finally reaching 2.5% in their latest release as second-quarter readings offered another upside surprise.

Consumer spending still underpins the economy’s current strength, which has been bolstered by a relatively resilient labor market despite the disappointing July jobs report.

The unemployment rate remains low by historical standards, and jobs continue to be added. The average year-over-year job growth in 2024 has been 1.7%, equal to its five-year pre-pandemic average. Moreover, the prime-age employment-to-population ratio rose to 80.9% in July, its highest level since early 2001.

Still, a labor market softening more than desired is a risk for future growth. As unemployment rises, consumers can quickly become less optimistic and pull back on spending, leading companies to slow hiring or cut staffing and sparking a vicious cycle.

Although that isn’t happening yet, a slowdown in consumer spending could also be triggered by pressure on the credit side. Savings accumulated during the pandemic are being drawn down, and consumers are leaning more on credit cards and personal loans.

The New York Fed recently released updates to its report on household debt and credit, showing total household debt rising to $17.8 trillion in the second quarter of 2024. Roughly 70% of this is mortgage debt, most financed at or below 5%. However, credit cards and auto loans are seeing higher balances, which carry much higher rates. The average rate for credit cards in the second quarter was 21.5%, for personal loans 11.9%, and for auto loans 8.2%. Retail card rates are far higher and often exceed 30%.

As household budgets become strained, more loan balances are falling into delinquency. In the second quarter, more than 9% of credit card balances were 30 days delinquent, and about 8% of auto loan balances fell into delinquency. Balances falling 90 days delinquent are also rising to percentages last seen in the wake of the Great Recession.

The Federal Reserve signaled at its last meeting that it considers the risks to the economy to be balanced. Instead of its primary focus on inflation, which has been cooling, it is now more watchful of developments in the labor market, given its importance in sustaining the economy. Should the trends in household credit persist, we can expect tapped-out consumers to cut back on spending, possibly marking the end of the cycle.

More recent conjecture is focused on how much the Fed will lower rates by and when. Some analysts suggested an inter-meeting rate cut, an intervention usually left for black swan events and times of crisis. But the odds of a 50 basis-point cut at the Fed’s September meeting rose substantially higher after last week’s developments.

At the time of writing, traders were pricing in a probability of 55% for the committee to take that action, according to financial services firm CME Group’s FedWatch tool, and a probability of 74% that 100 basis points would be trimmed by the end of the year, bringing the Fed’s policy rate to between 4.25 and 4.50.

We may hear something of the Fed’s thinking at the Jackson Hole Economic Symposium next week, where Fed Chairman Jerome Powell is slated to speak.