US economic outlook - Q3 2023

This is intentional. While headline inflation has slowed to a tolerable 3%, core inflation remains too high. A resurgence in energy and commodity prices could, potentially, cause a resurgence in prices. High interest rates, as well as a credit squeeze from banks following the banking crisis in Q2 are meant to constrict demand enough to prevent this from happening.

The US is still expected to outperform its developed market peers for three reasons.

1. It is ahead in the fight against inflation, as it tightened rates early and aggressively.
2. The Inflation Reduction Act has brough back several businesses and factories, boosting investment and output.
3. Consumption remains robust.

Consumption: During the pandemic, the US chose not to subsidize employment, like Europe, but consumption. This created a savings glut that could last between September 2023 to July 2024, before levels of consumer saving return to normal. As a result, consumption continues to beat expectations.

Labour Market: The labour market in the US remains relatively tight as a result of senior workers retiring early, and juniors opting to continue their education. The skills gap remains as pronounced as anywhere. While we expect that lacklustre demand should have an impact on unemployment, we expect overall conditions to remain tight for the foreseeable future.

Interest Rates: Interest rates are already much higher than average. Currently, the base rate sits at 5.25%. We expect it to climb as high as 5.75%-6% before the Fed stops hiking. Following that, however, and barring a financial accident, we expect rates to remain high for some time, until there’s evidence that inflation will come back down to the 2% target. Rates should be expected to return to “neutral” at some point late in 2025.

Inflation: Headline inflation may have fallen to 3%, but we expect that it will be much more difficult to get down from this level. Core inflation remains high, evidence of wage pressures on prices. Core consumer expenditure, the Fed’s favorite gauge of inflation, is significantly higher than average, to 4.6%. We believe that it will gradually come down, but we would be surprised if the 2% target was sustainably hit before mid-2024.

Real Estate: The US housing market remains weak, although in the past few months we have seen evidence of recovery. High interest rates have deterred many first-time buyers and are causing a deferral of purchase decisions. We expect the situation to normalize gradually, as rates are near peak and materials inflation has petered out.

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