(Bloomberg Economics) —
Doom-and-gloom talk prevailed as stock markets plunged last week. The pessimism seems to be driven by fears the days of booming corporate profits are over as consumers ease up on spending. Adding to that, FOMC participants’ hawkish rhetoric suggested a “Fed put” will be elusive.
The big question: Is the pullback in demand severe enough to tip the US economy into recession? In our view, that is premature. While the risk of a recession in late 2023 is elevated, we believe fundamentals are solid enough that demand will keep growth positive over the next 12 months.
Much of the gloom last week came from the poor performance of big-box retailers such as Walmart and Target. Bloomberg Economics noted earlier this year that the rotation into services from pandemic-supercharged goods — which, excluding food and gas account for only 20% of the consumer basket — will push demand lower in sectors like furnishing, apparels, electronics and other consumer discretionary items.
The rough patch for retailers is in line with our rebalancing scenario, rather than a sign of generalized deterioration in demand. Service spending, which is roughly double the weight of goods in the consumer basket, is still robust.
A record-low debt-servicing-to-income ratio — partly because many households have paid down debt during the pandemic — provides room for borrowing to support spending over the near term. That may explain why spending (PCE, Friday) remains resilient in the face of elevated inflation, and the sharpest increase in mortgage rate since 1990s has not caused a collapse in housing demand (Tuesday). For business investment, the backlog from supply-chain snarls over the past year has supported shipments. Initial jobless claims (Thursday), though creeping up, are still at low levels consistent with a tight labor market.
These signs of strength seem inconsistent with the recent plunge in consumer sentiment (University of Michigan survey, Friday). Though worth monitoring, sentiment gauges can be unreliable indicators of demand patterns for various reasons; among them, political affiliation has played a much more important role since 2016.