U.S. economic growth slowed significantly during the first half of the year, but inflation has remained a bit too high for the Federal Reserve’s liking. For that reason, the Fed has held off on making much-anticipated interest rate cuts.
Driven upward largely by government stimulus during the COVID-19 pandemic and supply chain disruptions, inflation peaked at 9.1% in 2022.In an attempt to fight inflation, the Fed raised its benchmark interest rate 11 times, from March 2022 to July 2023, to 5.3%.
The Fed’s efforts have helped curb monthly year-over-year inflation rates to below 4% for the past year. In June, the Consumer Price Index rose 3%, year-over-year, according to the U.S. Bureau of Labor Statistics, a major improvement from 2022, but still higher than the Fed’s 2% target.
Higher interest rates of course mean higher borrowing costs, and as economic activity has cooled, many American business leaders have been hoping to see the Fed lower rates. But rates have held steady for the past year as the Fed waits for inflation to slow further.
Federal Reserve chair Jerome Powell said recently that holding interest rates high for too long could jeopardize economic growth. But he also said the Fed still wants to bring inflation down to 2%.
U.S. GDP rose 4.9% during the third quarter of 2023, and then that growth rate slowed to 3.4% during the fourth quarter and 1.4% during the first quarter of 2024. The Federal Reserve Bank of Atlanta projects 1.5% GDP growth for the second quarter.
The U.S. labor market remains healthy but has softened a bit. The unemployment rate is at 4.1%, up from 3.6% a year ago. Maintaining low unemployment is the Fed’s other primary goal.
In the meantime, the economy is of course a critical issue for the presidential election in November and will remain a hot topic.
To gain more insight about the direction of the U.S. economy for the second half of the year and beyond, BizTimes Milwaukee editor Andrew Weiland interviewed Brian Jacobsen, chief economist for Brookfield-based Annex Wealth Management.
BizTimes: What’s your overall take on how the U.S. economy has performed during the first half of the year?
Jacobsen: “We’ve seen a slowdown in growth, but not a rapid one. Consumer spending has slowed to a more sustainable pace. This may be the first year since COVID when excess savings have been spent and people are no longer trying to make up for lost time and experiences during COVID. There was a lot of catchup spending and hiring over the last few years, distorting the economic numbers relative to long-term trends. Business investment spending is still very challenged. Unless it’s data centers, defense or motor vehicles, investment spending has been really low. High interest rates are hurting a lot of people and businesses, but spending by the biggest companies and the wealthiest households has propped up the aggregate numbers, masking the pain.”
Inflation has slowed significantly from its peak in 2022, but many Americans are still concerned about it and remember how much things used to cost. How do you feel about the current level of inflation in the U.S. economy and what do you expect for the rest of the year?
“Lower inflation does not mean prices will decline, it just means prices will stop rising so quickly. That’s a massive disconnect between the way policymakers think about the world and the way real people think about the world. The average pace of inflation from 1995 through 2020 was 1.8%. That meant that price increases were background noise. Suddenly, price increases are at the front of people’s minds. Inflation is likely to slow to something closer to 2% by the end of this year, but that doesn’t mean the prices will suddenly revert back to where they were four years ago. Time is a type of exposure therapy where after you see the price of bread around the same level for a while you start to accept that’s just the way things are supposed to be. It’s when you see a sudden jump in the price that you question what’s going on. Give it another year and people will just accept that the current level of prices is the new normal.”
The Fed raised interest rates several times to combat inflation but has held rates steady since July of 2023. When do you think the Fed will finally lower interest rates?
“It’s more a question of willingness than ability to cut. They’ll be able to cut come September, but they’ve made so many missteps along the way they’re like a deer stuck in the headlights. The Fed was too slow to start hiking. Prior to hiking they bragged about how a little inflation would be a welcome problem since they know how to fix that problem. Life has proven them wrong on that. Then they said inflation would be transitory and they really messed up by saying transitory meant six months instead of something more realistic like 18 months. Then after they hiked, they said there would be pain, but they misjudged how many people and businesses locked in low rates and how insensitive to interest rates a lot of spending is. All of these missteps have them terrified of trying to say anything about the future. By September, we should have enough data so they can have the confidence to start cutting rates.”
What effect are the current interest rates, the highest level in 22 years, having on the U.S. economy? Have we adjusted to these rates or are they still a significant drag on economic growth?
“Household and business debt loads are lower than they have been in a long time, it’s just the government that has a massive debt problem. It’s made it somewhat easier to deal with high interest rates. There are certainly individuals and specific businesses that are struggling under the burden of higher interest rates, but for the private sector as a whole, people and businesses are managing things well. The 2008 through 2021 period was the unusual period where rates were so low. Now we’re going back to a more ‘normal’ period. We will probably see mortgage rates gradually come down over the next two years, but my guess is that eventually 5% will be the new 3% on home loans and 3% will be the new 0% on savings accounts.”
This of course is a presidential election year. What impact if any do you think that is having on the economy?
“None. There’s a lot of talk about presidential election cycles, but most of that is based on very specific years or events that shouldn’t be generalized to every presidential election year. The election is important because it will affect policies in the future, but it is hard to point to a lot of evidence that it is currently affecting the economy. It shows up in the consumer sentiment numbers, but sentiment isn’t the same thing as spending. Every time a Democrat is in the White House Republicans have low confidence and every time a Republican is in the White House Democrats have low confidence. Consumer attitudes are very politically driven, but their spending isn’t. The biggest effect right now is around planning for what happens if the 2017 Tax Cuts and Jobs Act expires at the end of 2025 as scheduled or if only some provisions are extended. That mostly affects business planning and especially estate planning.”
Are you seeing any shifts in the labor market, or will it continue to favor job seekers?
“The headline jobs growth numbers mask what has been happening to specific industries and people. So, whether the labor market will favor job seekers or not depends on which jobs. It’s a mixed bag with many employers slowing hiring or even stopping hiring. They aren’t necessarily laying people off, but they’re not replacing people who leave.”
How does consumer activity look to you right now? Can consumers continue to power the U.S. economy forward or are there cracks in that foundation?
Consumer spending has slowed. The pent-up demand for trips and other experiences is fading. Excess savings from stimulus checks is spent. Consumers are trading down or reprioritizing how they spend their paychecks. Lower income households tend to have higher debt burdens and the cost of that debt is rising. Upper income households can now earn more on their savings. It’s really a two-track economy where some are doing fine and others are having to pinch pennies.
What do you think U.S. GDP will be for the remainder of the year?
“In 2023, GDP grew 3.1% in inflation-adjusted terms. It might be closer to 2% in 2024. It’s off to a bumpy start with first quarter GDP growth coming in at a 1.4% annualized pace. The second quarter might come in at about 2.2% annualized. Consumer spending only grew at 1.5% annualized in the first quarter and the second quarter isn’t looking much better. Investment spending by businesses might have to pick up to make up the difference to get to 2% for the year. The cost of borrowing to finance those investments is as high as it’s been in a while, so the Fed cutting rates at a gradual pace seems like a pre-condition to getting to 2% growth.”
Do you see a recession on the horizon or are we sticking the soft landing?
“I always thought the soft-landing analogy was a bad one. The Fed talked about the economy like it was piloting a plane. The Fed is powerful, but it doesn’t have a lot of control. Is it creating the conditions necessary for business owners to deliver value to customers and for households to make prudent decisions? The Fed isn’t the captain of a ship. Many businesses experienced their own mini recessions over the last couple of years. Many households did, too. Did we get a broad-based decline in economic activity to count as a recession? No, but that doesn’t matter to individuals. Will we continue to see struggles? Yes. Will we continue to see successes? Yes. We probably won’t see a recession this year or next, but a lot can change depending on policy actions from the Fed and the federal government. Stay tuned.”
