The US economy has defied expectations and remains far from the possibility of a recession, despite earlier warnings. The economy has been kept afloat by consumer spending, thanks to increased wages and steady employment rates, while businesses have also stepped up by retaining their employees. Although the economy has slowed since last year, it is still growing at a reasonable pace, which means a recession is unlikely to occur in the near future.
Gross domestic product remains the primary way of measuring the country’s economy, and predictions reveal that it is likely to increase at an annual pace of between 1% and 2% in the second quarter. Despite this slow growth rate, the US economy may have grown even faster in Q1 than previously reported, possibly at a rate of 2%. The updated figures are set to be released on Thursday.
While the current growth rate may be below the average of 2.3% from 2010 to 2019, there is still reason for optimism. Chief economist Gregory Daco of EY Parthenon believes that the economy might just recover from its current slowdown and avoid a long-forecasted recession.
The Effects of Interest Rate Hikes on the Economy
Since the spring of 2022, the rapid increase in interest rates was expected to trigger a recession. Such a rise in borrowing costs usually suppresses the economy by curbing consumer and business spending and investment.
The Federal Reserve decided to drive up a principal short-term rate to 5.25% from almost zero within 18 months. The intention was to tame high inflation, and they may hike the rates a few more times.
Higher rates have inflicted damage, primarily to the housing and manufacturing sectors. Home sales suffered and sales of significant manufactured goods also diminished as a result of the Fed’s aggressive measures.
Unexpectedly, the housing market looks like it bottomed out and may even be on the upswing. Manufacturing also appears to have stabilized.
Despite higher interest rates, consumers have mainly ignored their impact. They continue to spend heavily, especially on service industries such as dining out, traveling, and entertainment. They are even purchasing more new cars, demonstrating their confidence.
According to Richmond Federal Reserve President Tom Barkin, “Consumer spending remains resilient. Think of it as weaker but not yet weak.”
Moreover, households are about to receive another boost. The Federal Reserve’s battle against inflation is making steady progress. The consumer-price index-based inflation rate decreased from last year’s 40-year high of 9.1% to 4%.
Rising Wages Amid Tight Labor Market
Worker pay in the US has been rising faster than inflation for the first time since March 2021. Thanks to this wage growth and lower oil prices, consumers can now have more leeway to spend. The tight labor market is responsible for this increase in wages, with the unemployment rate near a half-century low at 3.7%. This means employees have more leverage over employers than they have had in decades.
However, the labor shortage is unlikely to ease anytime soon, even during a possible recession. The US population is growing more slowly while immigration has waned since the pandemic, and the percentage of workers aged 25 to 54 in the workplace is already high.
Although the Federal Reserve raised its GDP forecast for 2023 to 1.1% from 0.4%, investors and economists on Wall Street are still skeptical. If the Fed continues to raise rates, something has to give since almost every cycle of Fed interest rate hikes since World War II has been followed by a downturn. In fact, Chief economist Gus Faucher of PNC Financial services predicts a recession is likely “to start in late 2023 or early 2024, as the impact of higher interest rates continues to work its way through the economy.”
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