Consumers finished the third quarter strong as the still solid labor market continues to support spending, especially on services. But households are cutting deeper into personal savings and adding to debt, not a sustainable path for spending to remain buoyant in coming quarters. Headwinds for near-term activity are building, including rising interest rates, the resumption of student loan payments, emergent geopolitical concerns, and the potential for a federal government shutdown. This should result in significantly slower economic growth over the fourth quarter, a likely forerunner to a mild recession in the first half of 2024. The strength of recent economic data may even increase the odds of a recession as it reinforces a higher-for-longer rate path from the Fed into the new year.
- Job gains shocked to the upside in September, and sharp upward revisions to prior months suggest that the labor market hasn’t cooled much after all. Wage growth, albeit weakening gradually, continues to run faster than usual, indicative of ongoing tight labor conditions.
- Retail sales were robust in September as consumers for now remain resilient despite elevated inflation and climbing interest rates, but the housing market is at a standstill.
- Long-term interest rates rose to the highest levels since 2007, doing some of the work of tightening financial conditions for the Fed. Still, Fed officials remain biased towards restrictive monetary policy given the continued strength of the incoming data.
Analysis of current conditions:
Much stronger-than-expected hiring and retail spending in September suggest that activity continues to run too hot to meaningfully slow inflation in the near term. This complicates policy decisions for the Fed despite signs that corporate profits are waning in response to even tighter financial conditions and rising interest rates. The way forward for consumers may be tougher, too, as more households are turning to credit with excess savings nearly exhausted and student loan payment resuming. For now, the economy continues to hum along despite the building clouds on the horizon.
Outlook for the months ahead:
Economic growth remained robust heading into the fourth quarter, but headwinds for consumers and businesses continue to build and should slow economic activity sharply before the end of the year. Interest rates have climbed further, stifling the housing sector and business investment, while many households are hitting spending limits with pandemic savings exhausted and debt levels rising. For these reasons, we believe a recession will unfold over the first half of 2024, although the length and severity of the projected downturn should be relatively mild.