Trend watch and what’s new this week
Travel activity remains solid, closely tracking 2019 (slides 5 and 6). For instance, hotel occupancy continued to rebound, hitting 72.9%, which is the highest level since August 2019. Similarly, year-to-date air passenger counts are running modestly ahead of 2019.
However, container traffic in June fell 4.8% at the 4 top U.S. ports (LA, Long Beach, Savannah, SEATAC), and is down 23% year-to-date compared to 2022 and -6.1% compared to ’19.
Fed hikes another quarter point but vague on future moves
The Federal Reserve (Fed) increased its target range for the federal funds rate by a quarter point (0.25%) to a range of 5.25% to 5.50%. This was the 11th increase, taking the target rate up 5.25% in the past 17 months from essentially zero. Chair Jerome Powell’s tone was definitively neutral during the post-meeting press conference, walking a tightrope between hawkishness and dovishness. He deftly weaved positive and negative points into his responses to questions with the goal of creating maximum policy flexibility for upcoming policy decisions. If he was trying to be vague about future moves – either a hike, a pause, or an eventual rate cut – mission accomplished.
The Fed’s favorite gauge showed inflation remains sticky
On slide 7, the Fed’s favorite inflation gauge—the price index of core personal consumption expenditures (core PCE)—rose 0.2% in June and increased 4.1% from a year ago. It’s moving in the right direction and is down from its March ’22 high of 5.4%. Still, that remains uncomfortably high and well above the Fed’s 2% target, and likely contributed to the case for the July rate hike.
2nd quarter growth shows resilient consumers, businesses
On slide 8, we show the composition of second quarter gross domestic product (GDP), which grew 1.3% on an annualized basis. The biggest contributor in the second quarter was consumer spending, though the pace slowed compared to the first quarter, followed by business spending. Consumer spending, which accounts for nearly three-quarters of the U.S. economy, hit a fresh all-time high on a dollar basis. Conversely, residential building and net exports were modestly negative.
Weather impacted new home sales in June
On slide 9, new homes sales fell 2.5% in June to an annualized rate of 697,000, roughly in-line with the 20-year average and the December 2019 level. June sales may have been hampered by flooding in some areas of the Midwest, where sales dropped 28% for the month. Still, sales have increased in seven of the past nine months. Overall prices ticked down 0.5% in June yet remain 26% above the December 2019 level, supported by limited inventories of new and existing homes for sale.
Durable goods and core capital goods orders hit new highs
On slide 10, new orders for durable goods—big-ticket items such as equipment, machinery, electronics, and office furniture—jumped 4.7% in June, along with upward revisions to the May data. That isn't just a cycle high – it’s an all-time high, taking out the July 2014 high when Boeing booked orders for 324 planes for the rollout of the 737 MAX 200 plane. New orders for core capital goods, which exclude the volatile aircraft and defense components, also hit a fresh all-time high in June.
Services softer in July, while manufacturing still slumping
On slide 11, the preliminary July readings for S&P Global U.S. Purchasing Managers Index (PMI) for services slipped to 52.4 in July from 54.4 in June, though this was the sixth straight month of expansion. The U.S. manufacturing index improved to 49.0 but contracted for the eighth time in nine months.
Our take
The U.S. economy remains in a bit of a paradox. The good news is that the economy generally and consumers specifically remain more resilient than everyone expected, ourselves included.
As we have mentioned recently, the economy’s strength has increased the probability that the U.S. could skirt a recession – a so-called soft landing – has increased to roughly 40%.
Still, our base case remains for a recession, which is informed by both the slow down in the leading economic indicators along with persistent inflation, specifically the strength in the labor market. While inflation has has clearly peaked and is moving lower, it remains much hotter than anyone is (or should be) comfortable with. The Fed remains concerned about the labor market and wages.
Accordingly, the stronger the economy remains, the greater the likelihood that the Fed will need to continue hiking rates to tame inflation, which in turn increases the prospects of a policy mistake. In other words, overtightening rates such that it causes a recession (aka a hard landing) accompanied with job losses.
Bottom Line
A shallow recession remains our base case as dramatically higher interest rates and tighter credit conditions ratchet up stress on consumers and businesses going forward. This now includes restarting student loan payments later this year as a result of the recent federal debt deal. We also believe that the Fed will keep interest rates higher for longer. Yet, a recession isn’t inevitable.
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