Credit Sesame discusses whether the current economic conditions have resulted in a soft landing for inflation.
At the end of July 2023, Federal Reserve Chairman Jerome Powell announced that his economists were no longer predicting a recession. A couple of major banks also upgraded their economic forecasts. Does this mean the threat of a recession is over?
Combined with the easing of inflation, avoiding a recession would mean the economy had accomplished a soft landing. That’s where demand slows enough to cool off inflation without the economy plunging into a recession. That has been the goal of the Fed’s monetary policy over the past year-and-a-half, but it’s too early to declare victory. So far, the news is encouraging. However, there are still hazards to navigate, both in terms of inflation and a possible recession.
Economists react to good news
Fed Chair Powell stated that while his economic staff still expected the pace of economic growth to slow later this year, “given the resilience of the economy recently, they are no longer forecasting a recession.” Some major Wall Street banks are starting to see things the same way. JP Morgan Chase and Bank of America upgraded their forecasts to no longer include the probability of a recession this year.
In part, these economists are reacting to good news. The advance estimate of second-quarter economic growth from the Bureau of Economic Analysis showed Gross Domestic Product growing at a 2.4% inflation-adjusted annual rate, up from 2.0% in the first quarter. Employment grew for 31 consecutive months.
Meanwhile, on the inflation front, the Consumer Price Index rose at an annual rate of just 2.6% over the six months to the end July 2023. While not quite down to the Fed’s target of 2.0%, this marked substantial progress from the middle of 2022 when inflation was around 9%.
The progress on inflation is potentially good news for growth. It means the Fed may soon be able to stop raising interest rates, or even start to lower them. As long as inflation remains under control, this would allow the Fed to stop riding the brakes and let the economy roll.
It’s easy to see why economists are feeling more optimistic However, that doesn’t mean their optimism is correct.
Where have I heard this before?
To put the Fed’s improved economic forecast in perspective, here’s a reminder from Jeffrey S. Coons, Chief Risk Officer and Director of Institutional Services at investment management firm High Probability Advisors, “Fed Chairman Powell is currently saying the same thing that Bernanke proclaimed back in January of 2008.”
Indeed, then-Fed Chair Ben Bernanke was quoted in a January 2008 Reuters article as saying “The U.S. economy remains extraordinarily resilient.” Of course, we now know that January of 2008 was the month when the Great Recession began.
Nobody’s perfect. The point is not to second-guess Bernanke for an off-base forecast. It’s just a helpful reminder that economic forecasting is far from an exact science.
This is especially true when there are conflicting economic signals. While the economy has shown encouraging signs in terms of both sustaining growth and moderating inflation, there are still challenges on both fronts.
Threats to growth remain
In terms of growth, the economy’s run of four consecutive quarters of positive real GDP faces the following headwinds:
Debt is eating up a growing portion of household budgets
The Federal Reserve Bank of New York’s Household Debt and Credit report found that credit card debt crossed the $1 trillion mark for the first time in the second quarter of 2023. Overall consumer debt reached a record $17.06 trillion. These new highs are coming at a time when higher interest rates have made debt much more expensive. Credit card rates are up 6.25% since early 2021.
The combination of higher debt balances and rising interest rates means debt payments are taking a larger bite out of consumer budgets. The debt service ratio on non-mortgage consumer debt has risen by 17.65% over the past two years. This ratio measures debt payments as a percentage of discretionary income. After falling sharply in the first year of the pandemic, debt service ratios on non-mortgage consumer debt are now above their long-term historical average.
Tighter lending standards are making credit harder to come by
As debt burdens have increased, more and more consumers are showing signs of strain. The S&P Experian Consumer Bankcard Default index has nearly doubled since before the pandemic. New delinquencies of 90 days or more on credit cards have risen by 50% over the past year.
With borrowers heavily extended and increasingly having trouble paying their bills, lenders are responding by tightening their credit standards.
The Federal Reserve’s Senior Loan Officer Opinion Survey shows that several banks have tightened their lending standards for various forms of consumer credit recently. The Federal Reserve Bank of New York’s Credit Access survey found that rejection rates for credit applicants recently reached a 5-year high. In particular, lenders are being tough on applicants with lower credit scores, with most applications from people with credit scores of 680 or below now being rejected.
The resumption of student loan payments will force tough choices
Finally, a large unknown hangs over the economy in the form of the scheduled resumption of student loan payments later this year. A study by Oxford Economics suggests that the resumption of these payments will total over $100 billion a year. That’s money that could potentially be unavailable to consumers for other debt payments or spending.
Student borrowers could reduce those payments by signing up for an income-driven repayment plan. Historically though, borrowers have often failed to avail themselves of this option.
Each of the three factors detailed above represents a likely headwind for the economy in the months ahead. The economy has little momentum to spare, having grown sluggishly over the past year-and-a-half. So, despite the optimism of some economists, it may be too early to dismiss the possibility of a recession.
Inflation isn’t completely under control
The other component of a soft landing, getting inflation under control, is also far from a done deal. Certainly, the numbers in recent months look encouraging. But a growing number of examples of labor unrest show that workers want to catch up with the hefty price jumps of recent years. Their wage demands could spark another round of inflation.
Energy costs are also a concern. Energy is often the bell cow of inflation – and where it goes, other sectors follow.
The economy benefitted from falling energy prices for the year ending June 30. More recently though, strong demand and production cuts have caused a sharp rise in the price of oil. Since mid-year, the price of oil has jumped by 17.4%.
Looking at both growth and inflation, it’s fair to say the economy has come a long way in the past year. However, a soft landing for inflation still seems a long way off.
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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.