The Federal Reserve is pushing interest rates up to two-decade levels despite faster economic expansion in the spring.
Gross Domestic Product increased at an annual rate of 2.4%, adjusted for inflation and season, according to the Commerce Department’s report on Thursday. This was higher than the economists’ expectations and above the 2% annual growth rate in the first quarter of the year.
The second quarter saw a significant increase in business investment, despite a cooling of consumer spending. These factors helped to defy economists’ expectations that a recession would begin in the middle this year because of higher interest rates.
Solid growth, as inflation drops from historic highs, and the labor market is strong, adds to the prospects of soft landing — where inflation returns to Federal Reserve’s target with no recession.
Amy Crews Cutts said, “We have turned the corner in terms of the risk. Instead of heavily weighting recession, the data is balanced between recession and no recession,” before the release.
U.S. Stock Indexes fell Thursday. The Dow Jones Industrial Average dropped 237.40, or 0.67%. The S&P 500 Index dropped 0.64%, while the tech-heavy NASDAQ Index fell 0.55%.
The Fed increased its benchmark rate by a quarter of a percentage point on Wednesday, to a range ranging between 5.25%-5.50%. This is the highest level in 22 years. Fed Chair Jerome Powell stated that any future increases will depend on whether inflation or economic activity are slowing down in line with official forecasts.
He said that he was ready to monitor the data. Given how far we have come, he added, “we can afford to be patient and resolute as we watch this unfold.”
After a slight contraction at the beginning of 2022, the economy has grown by more than 2% in the last year. The rate of economic growth is similar to the one recorded during the decade prior to the pandemic.
Even though consumer spending has cooled, it still drives growth
In the second quarter of 2018, consumer spending increased at a rate of 1.6%, down from the 4.2% increase in the first. The bulk of economic activity is accounted for by household expenditures, which accounted for almost half of GDP growth.
The decline in sales was largely due to Americans’ cooling down of their purchases of large-ticket items. They had bought cars at the beginning of the year, as they flooded back onto dealer lots.
Vasant Prabhu, Visa’s Chief Financial Officer, said that lower gasoline prices are also due to the cooler consumer spending of recent months. According to energy data provider OPIS, the average price per gallon for regular gasoline has dropped by about 60 cents since a year ago. Prabhu stated that spending on other items has been relatively constant.
He said that consumer spending, from the wealthy to the low-spenders, has remained constant since March. “Our data does not indicate any change in consumer behavior across segments.”
Americans have benefited from a strong job market, where recent wage increases exceeded the slowing inflation. The Labor Department reported Thursday that initial claims, which are a proxy measure of layoffs and unemployment, fell by 7,000 in the past week, to 221,000 seasonally adjusted. This is an historically low level, which is almost identical to the average for 2019 when the labor markets was strong.
Gus Ayala is a retired banker aged 73 who spends lavishly on big-ticket items while cutting back on everyday purchases. El Mirage resident, Ariz. plans to purchase a hybrid vehicle later this year. He will probably finance it rather than pay cash. His and his wife’s savings buffer will help pay for his future trip to Iceland.
Ayala stated, “We are going to spend our money on things that will benefit us and allow us to enjoy life.”
Ayala altered his spending habits in order to deal with the inflation. Seattle’s Best was the cheaper alternative he chose after his favorite brand went up in price from $9 to $12. Ayala said he still needed his daily fix of coffee while enjoying his morning cup.
This spring, business investment has risen dramatically
The second quarter saw a sharp increase in business investment, which grew by 7.7% annually. This is compared to the 0.6% growth in the first.
Despite higher interest rates, some long-term factors are helping to boost investment. A increase in federal spending for chip-manufacturing facilities and electric-vehicle plants is offset by some other cuts.
As supply-chain problems began to unravel, business spending on equipment rebounded in the second quarter. In a note, Richard F. Moody said that as this process unravels, spending on equipment and machinery will likely fall again.
The slowdown in the global economy has a slight impact on net trade, which is reflected by a small decline in second-quarter GDP. Residential investment has declined for the 9th consecutive quarter. The recent declines in residential investments reflect the housing market’s strains due to higher mortgage rates.
A long-standing shortage of pre-owned homes helps support new construction. The worst of the downturn in the housing market may be behind us, which means residential investment will likely increase in the months to come.
Fears of a slowdown continue
It’s not clear if consumers and businesses will continue to spend the same amount later in the year.
The high interest rates will continue, increasing the cost of borrowing for construction, machinery, appliances and vehicles. Student loan repayments will also resume in the second half of this year. This is another factor that could affect consumers.
The chief financial officer of Unilever, the maker of Ben & Jerry’s ice-cream, Hellmann’s mayonnaise and Dove Soap–said consumers in North America “are starting to show signs caution” when they are spending off the excess savings that were built up during pandemic.
“We think that there is still a chance of a mild economic recession,” said CFO Graeme Pitkethly.
CertaPro Painters, a residential painting company in Aurora, Illinois, has received about 30% less requests from customers for estimates than they did a year earlier, according to Jesse Rodriguez, the general manager.
After two years of pandemic disruptions, the demand has retreated. The painting company was unable to hire enough workers in 2021. The firm had to deal with supply-chain issues that restricted the availability of paint last year.
“I thought ’23 would be a normal, regular year. But it hasn’t been,” Rodriguez said.
Rodriguez explained that the company recently reduced its marketing costs, including sending direct mail fliers out to potential clients.
Long-term outlook is positive
is reducing the fear of a recession among many economists who still expect the economic growth to slow down in 2020 and beyond.
The Conference Board reported this week that U.S. consumer sentiment continued to improve during July. Many Americans expressed more optimism for the future. Consumers are less worried about a possible recession.
The economy is also improving for small businesses. According to Vistage Worldwide (a business-coaching, peer-advisory company), 37% of small companies said in July that they believed the economy would worsen over the next year. This is the highest percentage since February 2022.
The International Monetary Fund said that the economic growth in the U.S. this year will likely be higher than originally estimated. The improvement in the outlook is due to a strong labor market, increased spending on tourism and other services as well as a reduced risk of financial instability.