Viewpoint with Stephen Gallagher
Will the US economy achieve that much talked about soft landing in 2024? As we begin the new year, we asked Chief US Economist and Head of Research Stephen Gallagher this and what else is on his radar - the good, the bad, and the ugly.
It seems the mood of pundits and the markets shifted dramatically towards the end of last year to one of great optimism with growing expectation that the US will avoid a recession in 2024? Is cheeriness warranted?
Well, SG anticipates rate cuts as early as this Spring and many other market experts have come around to this thinking more recently, which is largely behind the big shift in mood. But despite the market currently pricing in a perfect landing, SG still expects a mild recession in mid-2024. This will come as a result of the very tight monetary policies in effect today and our view that profit margins at US companies are going to fade, and that companies will need or will want to cut costs to preserve these profit margins as much as possible.
Do you think the markets have gotten a bit ahead of themselves?
To justify the market’s move higher, we think we still need to see some signs of moderation in our economy. The problem is that the evidence of moderation that the Fed is looking for and that will trigger their rate cuts will likely unnerve markets that are pricing in a goldilocks scenario. The good news is that the inflation rate has finally softened. Food and beverage prices have moved back to pre-Covid levels, food and energy is back to pre-Covid levels, and while rents remain elevated, they are softening. All of this opens the very real possibility of Fed cuts.
So, despite inflation softening and cuts likely on the horizon, you still anticipate a mild recession?
We’re slightly concerned that pricing power of companies has been eroded. Companies are beginning to announce sales and rebates that indicate this. More broadly for the economy, our number one lingering concern is in the inflation charts; that inflation is not going to hit the 2% target because of the rent component stubbornly refusing to come down enough. However, confidence is growing that we can accomplish this, but we do have a lingering worry. But the bigger worry is that rates are still too restrictive for businesses and households and on the overall economy. So, the Fed needs to start cutting rates because if the Fed keeps rates at current level, no question we’ll be in a recession.
What else worries you?
As we start the year, US banks, especially the regional banks – which have gotten a lot of attention – remain defensive with their balance sheets. Bank loans are still healthy, though. The loans are being repaid. But the value of the loans has been hit and this will take a long time to correct.
We also see mixed signals with consumers. While mortgage delinquencies remain very, very low, auto and credit card loans are showing troubling signs, as do college loans. And new loans like construction loans are constrained due to high mortgage rates.
What positive signs are you seeing in the economy?
Anecdotally, we hear a lot about a US business boom. It’s a compelling story but so far it lacks data-backed evidence. We actually think business investment is weaker than recognized. Not necessarily flashing danger but pretty flat-ish … with no evident strength in business investment.
However, we do see a healthy bounce in transportation investment such as airlines and autos, but coming off very low levels due to covid shutdowns. So, not exactly an unqualified strength.
Also, corporate profit margins are more resilient than we would have anticipated even though we are now seeing margins beginning to compress and, as I mentioned earlier, we’re seeing weakening pricing power of companies. Consumer pricing power is running at 2% (compared to 4%) together with higher labor costs running at 4%. This will mean companies will begin curbing hiring and starting to do layoffs.
More specifically, what do you see ahead for US jobs?
Employment is moderating, but it’s still too strong (for the Fed to cut comfortably). Hiring is still strong among nursing homes and hotels which haven’t recovered from their preCovid levels. But overall employment growth is slowing. We look for this hiring to go from a slowdown to weakness, which will trigger the rate cuts from the Fed.
It’s an election year. What can we expect from this, from an economic point of view?
We believe there will be little chance of major debt legislation in 2024 before the November election. This, in turn, means that getting a debt limit deal done by the Jan. 1, 2025 deadline will require fast action right after the election to avoid any negative fallout.
Also, we need to keep in mind that Trump’s temporary tax cuts expire after 2025. Are they extended after the election? That could have a big impact. Further out, we need to start reckoning with the inevitability that Medicare, Medicaid and Social Security trust funds will be exhausted in 2030-2035. The sooner we can grapple politically with these huge issues the better, but our current political climate doesn’t bode well for it.