Dodging a Bullet…for Now

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By: Simon Constable

Constable, a former Wall Street Journal TV anchor, is a fellow at John Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise.

For much of the last year and a half, Wall Street sent a consistent message: recession was imminent. Financiers were certain, because the Federal Reserve had pledged to crush inflation by sharply raising interest rates, which typically triggers a rapid slowdown. Yet, unlike in the past, no recession arrived. Unemployment remains low, with millions of unfilled job openings, and the economy keeps growing. “It’s hard to apply normal economic analysis in the post-pandemic world,” says Win Thin, global head of currency strategy at New York-based Brown Brothers Harriman. Hard, yes, but not impossible.

One part of the explanation is that the United States economy isn’t as sensitive to interest rates as it was prepandemic. “Consumers had more financial cushion than normal,” says Rob Williams, chief investment strategist at Sage Advisory in Austin, Texas. That resulted from the government’s epic pandemic stimulus, which totaled slightly more than one-fourth of the economy’s annual output.

Low interest rates during the pandemic sent real estate prices soaring, with homebuyers locking in super-low mortgage rates. The knock-on effect also produced what economists call the wealth effect, Williams says. When asset prices rise, including real estate, people feel wealthier and tend to spend more money. That in turn bolsters the economy. At the same time, the Federal Reserve endeavored to ensure that the financial markets continued to allow creditworthy businesses to borrow and raise capital. “They are acutely aware of the risks of the markets freezing,” says Konstantinos Venetis, director of global macro at TS Lombard in London. Indeed, the lack of functioning capital markets exacerbated the financial crisis of 2007 to 2009.

Still, lurking risks could raise the odds of a recession. For instance, the growth in the volume of loans that the banking system is making has slowed dramatically. In late 2022, the loan growth rate was 12.2 percent, but by the end of May, it had been cut almost in half. “If you look at economic growth and lending growth, there tends to be a strong correlation,” says Josh Steiner, managing director at Stamford-based Hedgeye Risk Management. His analysis shows if bank lending growth drops by four percentage points, GDP growth tends to fall by 1 percent in inflation-adjusted terms.

The planned resumption of student loan payments in the US, set to begin in October, could also have a deleterious impact on the economy. “Some people haven’t made payments in over three years,” Steiner says. If such loan payments were made over the last year, consumer-spending growth would have been halved to 1 percent. That likely means a consumer slowdown over the next year as loan payments kick in again. “It’s going to create a backdrop of slowing GDP growth,” he says.

Meanwhile, America’s trade partners aren’t doing well either. China, the second-largest economy, hasn’t performed as well as expected over the last few quarters. Its growth rate of below 5 percent remains at multidecade lows despite extra post-pandemic government spending. “We were counting on China to get us going,” Williams says. “The economic response has been underwhelming.”

It’s similar in Europe. “The European Union’s single currency area is in pretty bad shape,” says Thin. Germany, Europe’s largest economy, looks set to remain in a recession all year, and the rest of the bloc’s economies will likely follow suit. Meanwhile, as the Bank of England raises borrowing costs even further, the UK’s economy is likely to stall soon, he says.

“The US is the last man standing,” Thin says. Put simply, America remains in far better shape than most, at least for now.