The U.S. economy has drifted into the Great Uncertainty, which is defined as a multitude of contradictory data signals, a greater emphasis on state-led industrial policy (with massive amounts of money being pumped into targeted sectors over a relatively short period of time), and the popping up unexpected geopolitical problems. This is further complicated by an overarching and often contentious debate over the energy transition and climate concerns, played out against a backdrop of growing disenchantment with the political status quo and the growing shadow of AI. And conditions are likely to get worse before they get better.
What the “Great Uncertainty” also means is that the American public is pessimistic. According to a USA Today/Suffolk poll released on October 22, 2023, only 17 percent of Americans believe that the country is heading in the right direction; 71 percent thought it is heading in the wrong direction, with the rest undecided. The same poll asked, “How much confidence do you have in the nation’s leaders (White House and Congress) to handle the major challenges the nation faces?” Only 4 percent responded with “a lot of confidence” and 32 percent with “some confidence,” but 34.5 percent said “very little confidence” and 27 percent “no confidence.” Most Americans look to the future, its political institutions, and economic prospects with trepidation.
The Great Uncertainty is also reflected in the ongoing misses in economic forecasts. Many Wall Street mavens and many economist shops have been consistently wrong about interest rates through 2023, repeatedly calling for an end to the rate-rising cycle and a new cycle of rate cuts. The same has been true regarding calls for the next recession; several Wall Street economists and rating agencies called for one in the summer. Now, the call is for Q4 2023 or Q1 2023. The difficulty in getting it right was also evident in Q3 2023’s real GDP, which many thought would be lackluster; instead, the number came in at a rapid clip of 4.9 percent, hardly a sign of an economy heading into a recession. Bearing this in mind, will forecasts of a drastic cooling of the economy in Q4 and recession predictions hold up?
There are good reasons to believe in a more dire forecast. Consider the following.
Higher interest rates are beginning to hurt. The overarching concern is that the Federal Reserve’s mission to bring inflation to 2 percent will break the economy. Interest rate hikes have resulted in a significant slowdown in new debt origination, which raises questions about those parts of the corporate bond market that need refinancings (many high-yield companies that drank deep on cheap loans), which, in turn, is expected to squeeze corporate bottom lines and cause employment reductions as well as bankruptcies. According to S&P Global, corporate default rates are creeping up and are expected to hit 4.5 percent in the U.S. by June 2024 (from 3.5 percent in June 2023).
The housing market is being hard hit by higher interest rates. Looking at existing home sales, the market has not been this bad since 2009–2010, following the Great Recession. Existing home sales declined by 15 percent in September. There is a “deep freeze” in the housing market, characterized by rising mortgage rates, elevated home prices, and constrained housing inventory. Affordable housing is not on the cards anytime soon, especially if the Federal Reserve raises rates one more time and leaves rates higher for longer, which is a possibility. While sales of new houses increased by 12.3 percent in September, the main driver was buyers’ concerns that rates could go even higher. October’s number could point down.
Pandemic savings have largely been depleted, raising questions over the sustainability of the American consumer in the months ahead. According to Deloitte, household savings rates have dropped from an average of around 9 percent before the pandemic to around 4.5 percent in Q2 2023. This is important as consumer spending accounts for about 70 percent of U.S. economic activity.
Corporate earnings fade. Another point of worry is that the outlook for corporate earnings is weakening and could remain subdued through the last quarter of 2023 and into 2024. We caution on this as many companies provide more pessimistic future earnings, which makes it easy to beat earnings. According to Factset (as of October 2023), 73 percent of S&P 500 companies have reported a positive EPS surprise, and 66 percent have reported a positive revenue surprise. Despite the headwinds and some big company misses (Ford, Boeing, and Chevron Corporation), the likelihood of ongoing economic momentum in Q4 2023 could still see beats in earnings calls.
There are several other headwinds. These include the potential for a government shutdown and debt default, the UAW strike (which could spread), the resumption of student loan payments, problems in the commercial property sector, further upheaval in regional banks, and rising automobile payment delinquencies. Geopolitics could also be a significant factor, especially if either the war in Ukraine or the Middle East expanded, which could have a knock-on effect on oil and other commodity prices, putting more inflationary pressures into play.
However, there are contradictory data that point to continued economic expansion.
The U.S. labor market remains strong. On October 19, the U.S. Department of Labor announced that the number of Americans filing new claims for unemployment benefits fell to a nine-month low compared to the prior week. While most economists expected a softening in labor markets, what they got instead was weekly jobless claims decreasing by 13,000 to 198,000. Unemployment remains at a low 3.8 percent, reflecting ongoing demand for workers, the retirement of baby boomers, and smaller numbers of Millennials and Gen Xers. Tightness in the labor market is not going away any time soon, even with greater application of AI and robotics.
Services remain expansive. Although the ISM Manufacturing Index has been on an extended (though improving) downturn, the ISM Services Index has maintained a strong performance. Economic activity in the services sector expanded in September for the ninth consecutive month as the Services PMI came in at 53.6 percent. As one index respondent in the construction sector stated: “Conditions remain favorable for mechanical contractors. New construction projects continue to launch. We are still seeing opportunities for cost reductions across many commodities. Inventory levels on finished goods remain strong.”
Retail sales remain solid. In September, retail sales continued to expand despite consumers facing mounting economic pressures. According to the National Retail Federation, core retail sales in September were up 0.5 percent month-over-month and 2.2 percent year-over-year. The U.S. consumer has been written off before but has managed to chug along in the face of headwinds.
Industrial policy means big bucks and jobs. The primary factor for continued growth is structural—the Biden administration’s massive push for energy transition, addressing climate change, and decoupling with China. Although some of the programs started under the Trump administration, the combination of the CHIPS and Science Act, the Inflation Reduction Act, and other programs is pumping around $2 trillion into the economy in a relatively short period. This federal stimulus runs counter to the Federal Reserve’s effort to tighten monetary supply. Still, parts of the Homeland are seeing the construction of battery giga-factories, EV plants, lithium battery recycling plants, and CHIPS Act fabs. This re-industrialization surge also pushes the development of related infrastructure, including high-speed rail systems. The pipeline of federal cash is not going away in the short term and will be hard to reverse even with a change of administration.
The U.S. economy’s direction remains uncertain. The energy transition and decoupling from China represent positives for U.S. labor markets and industry, which might just help overcome the bite of higher interest rates. It is important to stress, though, that the balance between ongoing growth and recession is very narrow. It was Groucho Marx, who stated: “A black cat crossing your path signifies that the animal is going somewhere.” This is the challenge facing anyone trying to forecast the U.S. economy, as there are a lot of black cats crossing our path, making it difficult to calculate the right direction. Our advice: buckle up. The ride through the Great Uncertainty will only intensify, especially with elections looming on the horizon in 2024.
Dr. Scott B. MacDonald is the Chief Economist for Smith’s Research & Gradings, a Fellow with the Caribbean Policy Consortium, and a Research fellow with Global Americans. Prior to those positions, he worked for the Office of the Comptroller of the Currency, Credit Suisse, Donaldson, Lufkin and Jenrette, KWR International, and Mitsubishi Corporation. His most recent book is The New Cold War, China and the Caribbean (Palgrave Macmillan 2022).