What’s happening to the US economy?

The latest US gross domestic product data showed growth of 3.1 per cent, despite a period of prolonged interest rate rises in the country that would normally be expected to lead to a decline in the level of economic growth, and to higher unemployment.

The theory underpinning this is known as the Phillips curve, and posits the view that as inflation rises, so do interest rates, and then unemployment must rise, which slows down economic growth.

Miller explains that a series of unique factors combined as the US exited the pandemic era, creating a “Goldilocks” scenario of strong growth as rates were rising, but he adds that the momentum generated from the policies pursued by the US government in response to the crisis will wear off, while the full impact of rate increases has yet to be felt.

He says: “Coming out of the pandemic, the US economy received a massive stimulus — there was the Chips Act and the Inflation Reduction Act. On top of that, households had built up a large pool of savings.

US homeowners and corporates were less impacted by higher interest rates as they were able to take fixed rates on their mortgages and debt for the long termGuy Miller, Zurich

“And on the other side of the ledger, US homeowners and corporates were less impacted by higher interest rates as they were able to take fixed rates on their mortgages and debt for the long term, while the US is self-sufficient in energy, so there is less of a hit there.”

Miller says that with around 70 per cent of the US economy comprised of consumer spending, there is no short-term reason for the economy to slip into recession, “but I expect that higher interest rates will impact in the second half of this year”.

Jeffrey Cleveland, chief economist at Payden & Rygel in the US, tells FT Adviser that he expects there to be another wave of economic growth in the US in the coming months as petrol prices and inflation more broadly have come down, which boosts consumer spending power, particularly as wages have been rising steadily in the country. 

Pimco US economist Tiffany Wilding says the economy has been “resilient” despite government fiscal policy becoming more contractionary towards the end of 2023. 

House of cards

One consequence of US consumers’ ability to take on very long-term fixed rate mortgages has been that the housing market is “frozen”, notes Miller.

He says this is because moving home would involve taking out a new mortgage, which come with a much higher interest rate than the mortgages they are currently on, so they are reluctant to move house. 

This has a negative impact on economic growth in the short term, because people moving house generate activity through purchases of new furniture, and so on. 

Cleveland says that as rates are cut in the US, this should stimulate the housing market and produce the next leg of economic growth. 

Rates and measures 

Miller argues that the biggest challenge when assessing the progress of the US economy at present is that markets are pricing in extensive interest rate cuts, yet the purpose of reducing rates is to stimulate economic activity, and that may not be necessary at a time when growth is north of 3 per cent. 

He says the current strength of the US economy may mean rates are cut slightly later than might otherwise have been the case, but that as long as inflation is falling he expects rates to decrease. 

Cleveland adds that if the economy cools “even moderately” over the next six months, “then rates don’t need to be at 5.5 per cent and a cut would be appropriate, and if there are only two or three rate cuts in the US, that tells you that even if the economy does slow down, it’s not a calamity”. 

Wilding says core inflation has been falling at a faster pace than consumer price index inflation, though both are decreasing.

We’re seeing strong consumption and ongoing disinflation at the same time. This is the ideal scenario for the American economyChristophe Boucher, ABN Amro Investment Solutions

Core inflation aspires to remove the more volatile items from the inflation figure, while the CPI measure includes those. It is also the number that is prioritised by the Federal Reserve when it comes to setting interest rate policy. 

Cleveland says the higher consumer prices “weighed on confidence”, but that inflation is now noticeably declining in the US, which he feels should lead to increased consumer confidence and help growth maintain its current trajectory. 

Christophe Boucher, chief investment officer at ABN Amro Investment Solutions, says the most recent core inflation data was below 3 per cent, which he regards as positive, while consumer spending rose by 0.7 per cent.

“We’re seeing strong consumption and ongoing disinflation at the same time. This is the ideal scenario for the American economy,” he says. adding that this means the Fed “has no reason to rush” into cutting rates. 

Invesco chief market strategist Kristina Hooper says the Fed cares more about inflation falling than about whether growth declines, and as such may be happy to cut rates as long as the core inflation rate is falling. 

Global power 

Miller says the more positive outlook for the US economy is likely to bolster growth in the rest of the world, though he expects the impact will not be felt until 2025.

His says the eurozone economies are “in stagnation, with some quarters showing growth and some not, but basically all of it rounding to zero”, and those are precisely the conditions that would be expected to lead to rate cuts in the bloc.

But if the eurozone, or any other economy, cuts rates and the US does not, that would usually be expected to cause the value of the euro – or sterling if rate cuts happen in the UK prior to in the US — to weaken in value against the US dollar.

This would be expected to increase inflation in both the eurozone and the UK, particularly since oil and commodities are priced in dollars and any weakness in the US currency makes these more expensive. 

Miller says concerns of this nature will be alleviated by central banks communicating with each other, with the likelihood that there will not be a significant difference between rates being cut in each jurisdiction. 

The strength of the US economy has surprised many and caused sharp revisions to forecasts and market outlooks.

For investment managers, the next leg of performance for the US economy is likely to be very material to the returns they achieve for clients. 

david.thorpe@ft.com