US Outlook: Household Balance Sheets Are Relatively Healthy, And Household Credit Balances Have Been Increasingly Held
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Our central US outlook scenario is that of recession but a moderate one, so that we expect neither spiraling inflation nor a hard landing. The US economy is likely to be neither hot enough to induce an ultra-aggressive Fed response— what many refer to as a Volcker moment—that might crash the economy into significant recession, nor cold enough to severely impact the rest of the world’s growth.
Economic activity is decelerating. Are we headed for a recession?
The US economy has shown relative strength compared to other major economies over the past couple of years, but it is now decelerating. Negative GDP growth prints in the first and second quarters of 2022 were related to idiosyncratic factors, with temporary drags from inventories and trade. GDP decreased in the first half of 2022 as a result, but it rose again in the third quarter by enough to offset that decline. Despite that recent gain, the US economy is clearly decelerating as positive effects from the post-COVID reopening dissipate. The lagged effect of interest-rate increases should also have a dampening effect on economic activity. Various Measures of US Domestic Demand are Decelerating Exhibit 4: GDP, Final Sales to Domestic Purchasers, Final Sales to Private Domestic Purchasers, % Quarter-On-Quarter (Q/Q) Seasonally Adjusted Annual Rate (SAAR) February 2010–August 2022 Q/Q SAAR 10 0 2 4 6 8-2-4-6-8-10 Feb-10 Feb-12 GDP Mar-14 Apr-16 Final Sales to Domestic Purchasers Final Sales to Private Domestic Purchasers May-18 Jun-20 Aug22 Sources: U.S. Bureau of Economic Analysts (BEA), National Bureau of Economic Research (NBER).
Several measures of domestic demand and activity are showing a clear deceleration (see Exhibit 4). While GDP growth was 1.9% in the third quarter of 2022 compared with the same quarter of the prior year, basically matching the second quarter’s reading, final sales to domestic purchasers eased marginally to 1.2% from 1.3% and final sales to private domestic purchasers slowed to 1.6% from 1.8%. Other key economic indicators are also showing a controlled slowdown. For example, the Institute for Supply Management (ISM) Manufacturing Purchasing Managers’ Index (PMI) decreased to 48.4—below the 50 break-even level—in December from 56.1 in May, while the ISM Services PMI slowed to 49.6 in December from 58.3 in March.
Interest rates are starting to have some impact too. An example of this is the housing market, in which the rise in mortgage rates that has been seen during the Fed hiking cycle has resulted in housing construction turning downward (see Exhibit 5). Housing Has Reacted to Higher Interest Rates Exhibit 5: Housing Starts and Permits, SAAR January 2000–November 2022 MN SAAR 2.5 2.0 1.5 1.0 0.5 0 Jan-00 Nov-02 Sep-05 Jul-08 May-11 Mar-14 Jan-17 Nov-19 Nov22 Starts Permits Source: US Census Bureau.
Overall, we therefore believe the US is likely entering a recession, though we expect it to be moderate. A moderate recession—and, in this case, one with still relatively high but decelerating inflation—would allow the Fed to first pause and then slowly ease interest rates in due course, gradually removing this driver of USD strength from the picture.
Moderate or deep recession—what matters?
A key factor mitigating against a deep US recession is the still-robust labor market, which remains at historically tight levels (Exhibit 6). The strength in the labor market has driven an acceleration in nominal wage growth (Exhibit 7).
The combination of a resilient job market and rising wages supports labor income and, thus, overall household consumption. Consequently, while we anticipate the labor market to weaken, we expect its resilience to provide a base for stability in consumer spending, rather than the kind of steep contraction that might be associated with a deeper recession, such as that evidenced during the 2008 global financial crisis.
We also do not currently see the kind of large macro imbalances that would require corrections of the types traditionally associated with deeper recessions. At present, the biggest risk to economic activity would thus likely come from the Fed needing to overtighten to bring inflation under control, rather than from imbalances in the real sector (such as excessive inventories or over-investment in real assets) or in the financial sector (such as elevated household or corporate leverage). Inventories are low in some sectors and only rebuilding at a slow pace (Exhibit 8). Elevated housing prices have not driven a boom in residential construction (Exhibit 9 on the next page); if anything, there is still an under-supply of housing. Household balance sheets are relatively healthy, and household credit balances have been increasingly held by high FICO score households. One area of risk is the still-elevated level of home prices relative to rents (the housing market analogy of the equity price-to-earnings ratio) (Exhibit 10 on the next page). However, it appears that mortgages are in the hands of those with stronger balance sheets (Exhibit 11), and the importance of housing construction to economic growth is also much lower than what it was before and during the global financial crisis. The shadow banking system is not as large as it used to be (Exhibit 12), and asset prices have already experienced significant corrections. However, we recognize that there are risks in the financial markets from “unknown unknowns,” especially given the rising rate cycle
