In recent times, the resilience of the American economy has astonished many, persisting despite significant challengesThe Federal Reserve's aggressive hike in interest rates and a sharply inverted yield curve, often viewed as harbingers of economic recession, have not hindered growthIn fact, the annualized GDP growth rate for the third quarter surpassed expectations with a nearly 5% increase over the second quarter and almost a 3% rise compared to the previous yearThis leads us to question whether such outcomes warrant surprise, and the answer, intriguingly, is noThis divergence from anticipated results offers a compelling narrative regarding economic responses and underlying conditions.
The lagging response of the economy to policy tightening is an enduring principleEvidence suggests that these delayed reactions have extended since the early 1980sIn the past three endogenous recessions, the onset of recession lagged by 9 to 18 months following the Federal Reserve's final rate hike
Presently, we find ourselves approximately three months post the Fed's recent (and potentially final) hikeMoreover, it's noteworthy that inverted yield curves typically provide a two-year predictive window for economic shiftsThus, while recent metrics appear robust, we must consider whether they are simply transient insights concealing deeper vulnerabilities.
A prevailing sentiment among analysts champions the notion that “this time is different.” The very paradox of growth amidst elevated interest rates fuels this belief, bolstered by two compelling factors that may enable the U.Sto dodge the economic downturn commonly associated with such conditionsFirstly, during the pandemic, companies had the foresight and opportunity to refinance by issuing bonds at extraordinarily low interest ratesThis strategic move allows many large corporations to sidestep the immediate repercussions of increased rates
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Secondly, the pandemic-induced stimulus measures resulted in a surge in household savings, providing consumers with a significant cash cushion even in a tightening economic environment.
The question of how much cash consumers retain post-pandemic is hotly debatedAlthough retail sales indicate some resilience, the growth rate is not particularly robustFurthermore, mortgage rates have skyrocketed from an average of 2.9% to nearly 8%. This spike does not directly harm most homeowners with fixed rates but creates a disincentive for new homebuyers, evidenced by a drastic drop in mortgage applications to their lowest levels since 1995. Subsequently, new home and existing home sales have plummeted, with a corresponding downturn in building permits and housing startsSuch factors contribute to a cooling of a previously hot housing market.
Simultaneously, average credit card interest rates surge from 14.5% to 21%. The Federal Reserve indicates that the average U.S
household shoulders approximately $9,228.38 in credit card debt as of the end of 2022. As a result, households will allocate approximately $640 annually for debt repayment—collectively translating to an incremental $78 billion in expensesThough this figure represents just 0.3% of GDP, the ripple effect could constrain economic activities as obligations in auto loans and student loans diminish.
Overall, despite an impressive 2.9% year-on-year growth in GDP in the third quarter of 2023, consumer spending only rose 2.4%, notably below historical averages, while residential construction decreased by 7.8%. The federal government's non-defense spending increased by 6.3%, and defense spending rose by 4.9%, collectively acting as mainstays supporting economic growthIt’s important to note that the increase in non-defense expenditures primarily stems from the Inflation Reduction Act passed by the previous Congress, coupled with defense investments pertaining to global geopolitical tensions
Given the current political climate in the U.S., prospects for continued federal spending contributions to economic growth over the coming quarters appear dimThe rising inventory levels in the third quarter could further suggest a deceleration in future economic expansion.
Looking ahead, as we approach 2025, the prospect of several interest rate cuts from the Federal Reserve seems increasingly likelyThis leads to a pressing inquiry regarding whether interest rates can maintain elevated levels for the long haul.
Back in June 2006, after the Fed halted rate increases for three months, markets speculated potential reductions in the interest rate by 25 to 50 basis points by the end of 2008. However, very few anticipated the extent to which the Fed would eventually slash rates, ultimately driving them down to near-zero levels.
Interestingly, the Fed's actions following its last hike in July 2023 elicited similar market sentiment where there seems to be a consensus that multiple cuts may occur before the conclusion of 2025. Such projections are reasonable within the context of aiming for a soft landing amid persistent inflationary pressures