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How fast is the US economy slowing?

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Good Morning. Ethan and I are still debating one of the most meaningful meetings we can remember. Today we are trying to expand the lens and look at the economic context. Are we missing something? Let us know: robert.armstrong@ft.com and ethan.wu@ft.com.

Is the Fed kicking in an economy that has already fallen?

Yesterday the markets sent an unequivocal signal. Shares fell sharply across the board, with the exception of a handful of consumer goods and healthcare companies. Bond prices have risen (and yields have fallen). Translation: “There is going to be a recession! The Fed told us it would just control inflation! “

But take a step back. What is the state of the American economy? Is the Fed about to tighten the financial conditions in an economy that is already weakening – threatening not only a recession, but also a deep recession? What is the range of possible outcomes?

We know some important facts, albeit a little outdated. The labor market is very strong; There are twice as many vacancies as job seekers. Starting in March or April, Personal consumption, Industrial production and Business investment Emerged in inflation-adjusted real terms.

At the same time, there are many anecdotes, Society– Oh industry-Specific examples of slowdown in growth, which give the impression that cracks are forming on the economic front.

We also know that emotion is terrible. Surveys of consumers and businesses show ugly results, because rapid price increases scare everyone to death, properly. But so far, this has not had a significant impact on real activity. So let’s take out the survey data and look exclusively at activity.

What’s really going on?

First, it is clear that the housing market is slowing down. With mortgage rates close to 6 percent and climbing, demand is dwindling. The Mortgage Bankers’ Association’s index of purchase applications for mortgages fell by a third from its peak in January. Sales of existing homes are declining, but not as fast as those of new homes, which have fallen off the cliff along with housing starts, as this Pantheon Macroeconomics chart shows:

Outside of housing, the means of activity convey much more vague messages. The May retail sales report, which showed a 0.3% drop from April, caused a certain amount of handshake regarding the impact of inflation on consumption. However, without cars, sales increased by 0.5% in nominal terms of month over month. And it is not clear whether the softening of retail sales does not reflect the long-awaited turn back to services after a period of forced spending on goods. Consider this chart:

The drop in sales growth from month to month (pink line) looks less ominous in the context of the unusual growth bolus – which is more easily seen in year-on-year data (blue line) – that we have just passed.

Expenditure on durable goods rose during the Corona plague, remaining well below its peak in March 2021. Meanwhile, services spending has risen gradually, and will likely jump even higher this summer as everyone goes on vacation, believes Owen Brown of UBS Asset Management. The rotation is clear in the real PCE quantity index, which measures how many goods and services consumers bought per month:

Line chart of real expenditure for personal consumption, quantity indices (March 2021 = 100) showing good service

In other words, perhaps we are not looking at a decline in demand, but at a change in where demand is going.

So what about cars? Car sales fell 12% in May, but look at how volatile the figures are. The industry’s supply chain problems make it difficult to decipher basic demand:

Line chart of auto sales, percentage change month over month showing vehicle problems?

Finally, unemployment claims send faint signs that the labor market, although still hot, is cooling slightly:

Judging by activity indices, the U.S. economy is slowing, but the slowdown so far is mild and is concentrated in some significant areas, most notably housing.

The long-awaited “soft landing”, in which inflation falls without significantly high unemployment, is almost ruled out. We think the likelihood of a recession, roughly defined as the number of quarters of negative growth, is very high, given the Fed’s position. The central bank is almost determined to make the recession happen, but its depth remains an open question.

At the same time, the range of possible economic outcomes remains wide. This is partly because as we saw above, demand seems so flexible. Supply will also affect. The Fed can not count on ease of supply, but it may reach, and if so, the possibility of a shallow drop is much higher. The market is badly scared, but the economic story has not yet been written. (Armstrong II)

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