Will the U.S. economy be more resilient?

US Third-Quarter GDP Revised Higher to 3.2% on Firmer Spending

>> Is the "pain” in the US economy sufficient to bring inflation back to target?

We’ve already seen some signs of this resilience in the way that the economy snapped back in the second half of last year after the fall in H1. We believe that this resilience will show itself in 2023, and while that might mean faster GDP growth than we had previously predicted, it might also mean a higher rate peak.

We think that there are a number of places where signs of resilience can be found in the US economy. The most obvious is in the labor market, where there are still over 10 million job openings but only around 6 million unemployed. This Friday we should see another rise in payrolls of around 200k for December, and the unemployment rate is likely to stay stubbornly below the 4% level that the Fed seems to think represents full employment.

Of course, tight labor markets can be found throughout the G-10 countries at the moment; they are not unique to the US. However, there are other signs of resilience in the US that do not seem so prevalent in other developed countries and could therefore mark the US out as the economy least likely to slip into recession this year.

In our view, one particular area of resilience lies in bank credit. The latest data on lending by US commercial banks shows an annual increase of over 11%. That’s very strong indeed, and if you think that’s because inflation is lifting the value of loans demanded, then just consider that lending by euro zone banks is only running at a 2.9% annual pace at the moment and an even lower 2.2% in the UK.

Why is this resilience in US bank lending significant? One way to think about this is to consider the inversion of the US yield curve, which many, if not the majority, see as a sure sign of an impending recession. An inverted curve has proved to be a good sign of recession in the past, largely because it heralds a slump in bank lending. Banks borrow short and lend long, and when the yield curve is inverted, lending can slump as potential returns to banks decline relative to their cost of funding. But lending has not fallen this time, or at least not so far; on the contrary, it has increased.Part of this might be due to the robust demand for loans, for while policy rates have risen sharply, real policy rates remain deeply negative if we take the current inflation rate as a proxy for expected inflation.

As far as banks are concerned, their cost of funding has risen only modestly relative to the rise in the fed funds target given that much of the funding comes from customer deposits and the rates on these have risen only slightly, which has, in fact, led to something of a deposit drain.

>> How strong is the U.S economy?

Some estimates suggest that in Q3 the banks' cost of funding was around 0.6%, clearly far short of policy rates back then and even more so now. In time, this cost of funding will rise and could slow bank lending, in addition to a possible decline that results from a drop in demand for loans. But so far at least, the resilience of bank lending does not seem to be suggesting that the US economy is edging towards a recession.

This being said, a two-quarter fall in GDP, which other countries define as a recession, may still happen in 2023, just as it did in 2022. But the designation of an official recession by the adjudicators, the National Bureau of Economic Research (NBER), still seems a less-than-even possibility in our view this year, and we have actually lifted our forecast for US growth this year to 1.0% from the 0.0% that we had suggested previously.

Even though this adjustment does not materially impact our call for inflation to fall to 4% this year, we do believe that the risks to the 5% peak for the fed funds target that we have suggested before lie on the high side, and hence we’ve nudged this up to 5.5%. While we have forecast that the Fed will move straight to this level at a steady pace in the early months of this year, a brief pause followed by subsequent rate hikes is also very possible in our view.