For the past year, many commentators have suggested the US economy is about to fall into recession. The major leading indicator referred to in these stories of doom has been the US yield curve.
The problem is that short rates have been rising relative to long rates. The indicator we use is US 90 Day yields relative to US 10-year bond yields. On 21 July 2023, at the time of writing, US 90 Day yields are 1.66% higher than 10 year bond yields. The result of this should be that these high short rates choke off the flow of capital for investment in the US economy. This slump in investment should then result in a slump in US GDP.
This is not happening. Instead of a sharp slump in activity, growth seems to have slowed to what economists call a "soft landing". A soft landing means that growth is positive but remains below trend for an extended period. Some forecasters suggest this is the best possible outlook. These forecasters should be careful what they wish for.
In Figure 1 above, we show the outlook for the period from the end of 2023 to the end of 2026. Trend growth rate for the US economy is 1.8% GDP growth per year. This growth rate is the combination of productivity growth plus growth in work force plus immigration. The figure of 1.8% that we use is based on longer-run estimates provided by the Federal Reserve.
The outlook for the US economy provided by both the Federal Reserve and commercial forecasters is that growth will be positive in 2023, 2024 and 2025 but remain below trend. As a result of this, unemployment will rise slowly from 3.6% in 2023 to 4.0% in 2024, 4.6% in 2025 and 4.8% in 2026. This outlook of slow growth and rising unemployment suggests that Americans will experience a period of extended misery as their economy crawls through the period of the next three years.
How come we are so lucky?
Why is it that the US now looks likely to have this extended slowdown instead of a sharp recession? The answer is that while interest rates have been rising, the US Federal government has been leaning against the monetary policy of the Federal Reserve by providing a continual period of strong fiscal stimulus. We can see this fiscal stimulus in Figure 1 above. These are our calculations of the unified Federal surplus as a percentage of US GDP.
The long-term median of the US budget deficit since 1930 has been 2.9% of US GDP. The deficits we calculate for the next period 2023 to 2026 is that the US Federal government has a deficit in 2023 of 6.4%. This declines slightly to a deficit in 2024 of 5.8%. This rises to a deficit of 6.0% in 2025 and 5.9% in 2026. This means that the US budget deficit is providing around 3.9% of GDP of stimulus relative to the long-term median at the very same time as the Fed has increased interest rates so far by around 5%. This means that negative shock of monetary tightening is being absorbed by the continued provision of fiscal stimulus. This is the source of the mysterious and unusual "soft landing" that the US economy seems likely to experience for the next two to three years.
Soft landings do provide the benefit that corporate earnings do rise but at a very modest level. This produces an increase in earnings in nominal terms rather than real terms. Put together with stable interest rates, this provides a reasonably stable outlook for US equities. At the same time, continued budget deficits which are larger than the budget deficits in the European Union, should result in a gradual decline in the US dollar, relative to the Euro and other reserve currencies such as Sterling. This provides the possibility of gradual but steady rises in commodity prices.
All of this may seem reasonable and indeed a healthier outlook for financial markets. However, for many US citizens over the next few years; the US economy may be an extended period which is anything but enjoyable.
This report was prepared as private communication to clients of Morgans and is not intended for public circulation, publication or for use by any third party. The contents of this report may not be reproduced in whole or in part without the prior written consent of Morgans. While this report is based on information from sources which Morgans believes are reliable, its accuracy and completeness cannot be guaranteed. Any opinions expressed reflect Morgans judgement at this date and are subject to change. Morgans is under no obligation to provide revised assessments in the event of changed circumstances. This report does not constitute an offer or invitation to purchase any securities and should not be relied upon in connection with any contract or commitment whatsoever.
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