07 Sep 2023 4 min read

We are never ever getting back together

By Tim Drayson

Excitement around a US soft landing continues to build, yet we think some of the positive news on growth and inflation is temporary. We maintain our view that it will be difficult for the Federal Reserve to hit its inflation target and avoid recession.


US growth estimates for the third quarter have been moving higher. This follows benign inflation prints in June and July and signs of a gradual loosening of the US labour market.

We have previously written about the stealth fiscal easing which has surprisingly boosted growth over the last year. More recently, there have been some additional factors which have supported US growth.

Jump then fall

Consumer spending is on course for a strong summer. This is not underpinned by real disposable income growth. Instead, in the initial vintage of the data, there has been a sharp decline in the saving rate to near cycle lows. This is unexpected given our view that excess saving is nearly exhausted and that the saving rate is under pressure to rise from higher rates, tighter lending standards and lower real wealth.

Some of the drop in saving is involuntary. Electricity consumption has surged owing to the hotter-than-normal weather. But some has been discretionary. Demand for experiences continues to normalise and this summer has seen ‘The Eras’ concerts from Taylor Swift, ‘Renaissance’ tour from Beyonce and ‘Barbieheimer’ blockbuster movies. Collectively they appear to be impacting the macro statistics.

Combining the associated spending on travel, accommodation, and food and drink consumption alongside the direct ticket costs could be adding 0.6% to GDP growth in the third quarter of this year, with a similar hangover effect in the fourth quarter.


Separately, we believe there is likely to be a positive contribution to third-quarter growth from inventory accumulation. Auto production has picked up in recent months, even though sales are essentially running sideways. While this higher level of production can be maintained for a while as inventories replenish, autos are unlikely to contribute further to growth.

I knew you were trouble

These effects should unwind quickly, and then the US runs into a series of headwinds. Student loan repayments begin in October, which – all else equal – will subtract 0.3-0.5% off disposable income among households with relatively high marginal propensities to consume.

Fiscal policy is turning more restrictive both at the Federal level and state and local government level. Residents and businesses across most counties in California have benefitted from stronger cash flows following a six-month delay to taxes, but these come due in October.

The weakness in Federal tax receipts is partly down to California and lower capital gains taxes after the asset price declines in 2022. But business tax refunds have surged this year due to the Employee Retention Tax Credit. Business which suffered a drop in revenues but retained staff during the pandemic are eligible.

Recently we have seen a proliferation of companies dedicated to claiming on behalf of small and medium-sized businesses. But the IRS has begun to slow processing amid concerns around fraud. Even without some businesses being made to pay this money back, this is a potential negative swing of over 0.5% of GDP going forward as the tax credit winds down.

Real incomes have received a near 1% boost from the decline in energy prices over the last year, but in recent weeks gasoline prices have begun to climb higher again, and this should be reflected in a large increase in headline inflation in August.

The early September monthly construction data suggest the exceptional surge in manufacturing investment in structures is coming to an end. Even if the level of spending remains high, as we expect, the contribution to growth should quickly fade.

US exports offer no escape given weakness in China and Europe and a still relatively strong dollar. There is also the potential for a United Auto Workers strike, a US government shutdown and Panama Canal disruptions.

But the main driver of our recession view is the lagged impact from tighter monetary policy. While we are not an advocate of the Federal Reserve (Fed) balance sheet driving markets, ongoing Fed quantitative tightening should have an effect on bank-lending behaviour as pressure on their deposit base continues. This is alongside signs of rising delinquencies, which are already making the banks tighten lending standards. The resetting of corporate debt-servicing should continue while fresh borrowing will likely be deterred by relatively high interest rates. With corporate margins under pressure, the outlook for business investment remains weak, in our view.

End game

While our estimated timing of recession continues to drift out, and is now around the turn of the year, we expect all these factors to be weighing on growth. There are parallels with the year 2000, when the Fed felt comfortable holding rates in restrictive territory through the summer and autumn only to be surprised by the extent to which the economy slowed. This triggered an emergency rate cut in January 2001.

However, with inflation more of a constraint today, we believe it will take greater economic weakness this time around for the Fed to suddenly reverse course.

Tim Drayson

Head of Economics

Tim keeps a close watch on global economic developments, with a particular focus on the US. He believes nothing good ever happens after midnight, which is why he is rarely spotted out late. Tim joined in 2008 from the number-one ranked economics team at ABN AMRO, with prior experience from HM Treasury, and graduated with a MSc from the University of Nottingham. When not crunching economic data, he can be found studying the weather forecast, analysing his cycling statistics or looking anxious on three-foot putts.

Tim Drayson