InfraCap Weekly Commentary, New York, September 17, 2023 ~ Most economic forecasters spend an inordinate amount of time focusing on minor influences on consumer spending such as student loan payments or Pandemic savings balances. Consumer spending is 66% of GDP but is extremely stable and almost exclusively driven by employment and wages. Consequently, a sudden drop in personal consumption has never precipitated a recession.
Every post-WWII recession has been caused by the Fed tightening monetary policy which causes long-term interest rates to increase, resulting in large reductions in business investment. In the 11 post-WWII recessions business investment dropped by an average of 13.4% while consumer spending was slightly positive on average. Business investment is 21% of the US GDP. The plunge in business investment causes large layoffs in the construction and manufacturing sectors, which causes consumer spending to drop from its normal real growth rate of 3.3%, which makes the recession deeper. The average post-WWII recession had an average drop in GDP of 2.3%, indicating that more than 100% of the decline came from the drop in business investment spending.
This Fed tightening cycle is very different from the prior 11 recessions due to Pandemic-related effects and impacts of the financial crisis.
The US has a shortage of housing with the inventory of new and existing homes for sale at an all-time low. The shortage is partly due to hangover effects from the housing crash as builders are now more conservative and there were also disruptions of housing construction during the Pandemic.
There is also a shortage of new autos for sale as a result of the auto chip production disruption. These shortages are supporting the housing and auto sectors.
Also, the share of mortgages that are floating rate has dropped from 20% before the financial crisis to 6%, cushioning the impact of higher short-term interest rates.
In addition, spending related to the ARPA, IRA, Chips Act, and the Infrastructure Bill are supporting construction and fixed investment which is preventing layoffs.
Finally, the labor market is being supported by the shortage of workers that developed during the Pandemic.
Consequently, we continue to forecast that the US economy stays out of a recession during this Fed rate tightening cycle.
We do forecast that the Eurozone will enter a recession in the second half of this year. Germany is already in a recession with negative growth over the last four quarters, and plunging industrial production and retail sales recorded in July with both declining at almost a 10% annualized rate. The Eurozone also is more vulnerable to ECB rate increases with 45% of mortgages floating rate. We expect the ECB will ease rates in the first half of 2024 in response to the recession, which should cause global rates to decline.