2024 Q2 Economic Update
Despite an unexpectedly strong U.S. economy, developments in the first half of 2024 have reinforced our belief that a high-interest-rate environment is here to stay. US Industrial Production remains slightly below last year's levels on an annual basis, and overall US Real GDP growth is slowing.
Consumer price inflation is moving favorably for the Federal Reserve and consumers, potentially motivating near-term rate cuts. This bodes well for business-to-business spending, which is expected to rise in 2025. However, rate cuts are likely to be mild due to structural constraints such as elevated government spending and a shortage of workers. Prior to the release of June’s Consumer Price Index (CPI) data, the Fed's messaging was somewhat dovish, supported by a mildly softening job market. The US Unemployment Rate rose to a seasonally adjusted 4.1% in June, historically low but up 0.7 percentage points from its low point this business cycle. The June CPI data reinforced this dovish sentiment, with year-over-year inflation falling to 3.0% from May’s 3.3%, although it remains above the Fed’s 2.0% target. The shelter component of the CPI is a significant contributor to persistent inflation. High interest rates deter purchases of goods and services, but their impact on shelter costs is less clear. Many homeowners with low fixed interest rates are reluctant to list their homes due to high rates, limiting supply and driving up shelter costs. Excluding shelter, inflation in June was 1.8%, a rate the Fed would favor for future rate cuts.
Business-to-business spending has remained relatively flat recently, and we anticipate a flat-to-mild decline in the near term. Backlogs are diminishing, as indicated by US Nondefense Capital Goods Unfilled Orders (excluding aircraft), which are below last year's levels. Producers are likely facing softer demand, varying by industry, though growth is expected to resume in 2025.
Our leading indicators are generally rising, albeit weakly, supporting our forecast for a slightly stronger economy in 2025, especially in the latter half. At this time, we do not believe the slowing economy will turn into a macroeconomic recession, but expect some concerning months or quarters highlighted in the headlines.
Oh yeah... there is also a US presidential election coming up. Expect increased consternation, finger-pointing, and politicking of the data. Be wary of economic statistics trumpeted in the news media to endorse or criticize a political candidate.
Here is a summary of the key metrics we follow:
Retail Sales:
Consumer spending has been relatively resilient despite higher interest rates. US Total Retail Sales continue to rise, even when adjusted for inflation. Our analysis indicates that middle-to-upper-income consumers are driving much of this increase, while lower-income consumers are more affected by inflation and high interest rates. Overall, we expect retail sales growth to slow in the coming quarters.
US Total Retail Sales in the 12 months through June were 3.1% higher than the previous year, although growth is slowing. Different components of Retail Sales are trending variably due to differing pricing pressures. Growth rates are highest, though decelerating, for restaurant and bar sales as well as non-store sales, while gas station sales have fallen below last year's levels. Overall, growth is expected to generally slow in the coming quarters.
The US Total Retail Sales quarter-over-quarter had been gradually increasing since mid-2023, but this trend tentatively reversed, dropping to a nine-month low of +2.9% in May. In general, we are seeing the consumer temper their spending much as a balloon with a small leak, slowly losing air over time. The "losing pressure" analogy is more evident in the seasonal rising trend. At +8.1%, the seasonal rise from the March low is milder than normal, which is a noteworthy deviation from typical seasonal trends.
Labor Markets:
In June, employment reached a record high, increasing by 1.5% compared to the previous June. While the 1.5% rise might seem modest, the record high is noteworthy. However, a closer examination reveals underlying weaknesses. We are seeing slowing growth in employment, and the 1.5% year-over-year increase is the weakest in over three years. Additionally, the month-to-month change in employment was weaker than normal in three of the last four months. The June month-to-month change alone was comparable to years associated with macroeconomic slowing growth or recession.
Construction:
Currently on the cusp of a slowing growth trend, US Single-Unit Housing Starts are expected to flatten and then decline slightly into early 2025. With mortgage rates hovering around 7%, many potential homebuyers are stuck with “golden handcuffs,” as their existing mortgage rates are often at or below 4%. Consequently, many homeowners are choosing to wait for rates to drop before moving.
While a potential Federal Reserve interest rate cut later this year may provide some relief from high rates, a significant decline is unlikely in the near term. This means the low activity in the single-family resale market is expected to persist. As a result, housing prices are rising as the few homeowners selling seek to cover anticipated higher costs.
Total nonresidential construction in May was 13.7% above year-ago levels. Mild deflation in US New Nonresidential Construction Producer Prices, coupled with the lagged effects of slower economic growth, will weigh on construction spending in the coming quarters. Sectors benefiting from infrastructure funding are growing robustly, but this growth rate is likely unsustainable in the long term. Total residential construction rose in May, up 1.2% from the previous year. US multi-family construction is in early decline, with further decline probable as multi-family housing starts are down 30.5% year-over-year.
Given that the housing market is a leading sector of the economy, trends in US Single-Unit Housing Starts generally precede trends in US Industrial Production by roughly three quarters. Thus, even if your business does not operate in the housing market, these trends are relevant for future planning. Although we do not expect the industrial sector to follow housing market trends exactly during this business cycle, we anticipate an upturn in manufacturing activity in 2025. Additionally, due to the “golden handcuff” effect, those remaining in their homes likely have extra spending money because of their lower housing costs. This contributes to our expectations for a non-recessionary scenario for US Total Retail Sales and US Real Gross Domestic Product.
Manufacturing:
Manufacturing, representing 10.4% of the economy, has been struggling due to higher interest rates that reduce demand for goods and complicate capital investment. However, there is optimism for increased factory activity, with the Federal Reserve expected to begin easing monetary policy in September as inflation subsides. Motor vehicle and parts output rose 1.6% in June after remaining unchanged in May. Durable goods manufacturing production was flat. While the production of motor vehicles, parts, electrical equipment, appliances, and components increased, declines were seen in fabricated metal products and miscellaneous goods. Nondurable manufacturing production rose 0.8%.
Capacity utilization in the industrial sector, measuring how fully firms use their resources, rose to 78.8% from 78.3% in May, just below its long-term average. The manufacturing sector's operating rate climbed to 77.9% from 77.6% the previous month, slightly under its long-run average. However, the US Manufacturing Capacity Utilization Rate is also slightly below year-ago levels on a month-over-month basis, suggesting a forecast for flat to mild decline in the near term. However, a mild rise in several key manufacturing leading indicators points to slightly higher manufacturing activity in 2025.
US Nondefense Capital Goods New Orders (excluding aircraft) in the 12 months through May were 0.9% above the previous year's level. Due to elevated financing costs, businesses are likely postponing larger investments until rates are cut.
Specific Items to Consider at the Macro Level are:
Retail Sales:
Some parts of Retail Sales may endure a hard landing in the near term while some may only see a soft landing. Research the likely direction of the markets your company serves and plan accordingly.
As always, know your customer as demographic and migration movements impact demand for brick-and-mortar retail.
Improve your margins and focus on your competitive advantages ahead of the next uptick in inflation which we anticipate will start in mid-2025.
Construction:
Cash is king, especially on the back side of the business cycle. Ensure you have enough cash on hand to withstand the upcoming slowdown.
Assess your cash flow projections with higher scrutiny and more frequency to ensure you avoid getting squeezed while New Starts remain under the current level through the remainder of the year.
Be prepared for a continued decline in the remainder of 2024. Consider using this time to make process improvements.
Plan at least half a business cycle ahead so that you are not caught off guard by changes in the economy.
Manufacturing:
Evaluate your company’s productive capacity. Anticipate bottlenecks that may hinder your ability to take advantage of the upcoming rise in 2025 and make the investments necessary to alleviate potential difficulties.
When adjusting your inventory levels for the remainder of the year, be mindful of the rise coming in 2025.
In anticipation of the coming recovery in 2025, note prices for finished goods are likely to be higher in 2025 and 2026 than in 2024.
Different sectors of the economy will perform differently. Make sure to research the sectors your company serves to plan resource decisions.
Communicate your competitive advantages to gain market share as spending on machinery plateaus.
The rise in 2025 and 2026 will take New Orders into record territory. Is your business prepared for increased activity from a labor and capital perspective?