Is the American economy immune to crises?

In this article, we will explore the current panorama of the US economy and how five crucial factors have propelled its performance beyond expectations. We will investigate how the accumulated savings during the pandemic, the dynamics of interest rates, fiscal stimuli, the labor market, and housing scarcity have contributed to the economy’s robustness. However, our analysis does not stop here. We will discuss the potential risks that still loom on the horizon, such as the return of inflation and prospects of growth slowdown.

Discover the secret of why the US economy remains resilient. Five crucial factors have driven the American economy beyond expectations: the savings accumulated by consumers during the Covid-19 pandemic, the ability of borrowers to lock in low interest rates for extended periods, significant fiscal stimulus, a competitive job market, and a shortage of houses in the market.

While there are reasons for optimism regarding the macroeconomic outlook, two major risks still linger on the horizon: the possibility of inflation’s return and a potential sharp economic growth slowdown.

It’s advisable to adopt a cautiously optimistic approach with your investment portfolio, diversifying your resources across different sectors, regions, and asset classes.

With the recent increase in interest rates, the Federal Reserve (the Fed) raised the cost of borrowing by a surprising 5% in just over a year. Given this scenario, it was expected that the economy would face challenges, but surprisingly, it continues to be resilient and outperforming expectations. It’s worth analyzing how this was possible.

Why is the US economy doing so well?

1. Consumer spending remains strong, driven by savings generated during the pandemic. Lockdowns and government aid led US consumers to spend less and save more, creating a robust savings cushion. This cushion boosted spending, initially on goods (such as exercise equipment and home office furniture) and more recently on services (travel, dining at renowned restaurants, and personal care). While these savings are tapering off, a resilient job market and renewed consumer confidence continue to drive spending – a critical factor as consumer spending accounts for over 70% of US economic growth.
2. Businesses and consumers are benefiting from long-term low interest rates. After the global financial crisis, debt with fixed and extremely low interest rates became popular. This allows consumers and businesses to secure financing at ultra-low rates for many years. Whether in auto loans, mortgages, or long-term bonds, a significant portion of existing debt still maintains the low interest rates of the past. Many companies have indeed managed to reduce interest costs relative to profits. Furthermore, by successfully passing price increases on to consumers, they’ve maintained strong and healthy profit margins. Therefore, it might take some time before interest rates truly impact the economy.
3. Large fiscal stimuli have come into play. The Biden administration vigorously advocated for a $1 trillion infrastructure package, along with legislations that injected capital into renewable energy and semiconductor sectors, providing a crucial boost to the economy. Passed in late 2021, the bill bolstered manufacturing and infrastructure, resulting in an 8% annualized increase in business investment in the second quarter of this year. This fiscal stimulus helps explain the relative resilience of the US economy.
4. Worker shortage has driven hiring. The job market is engaged in a risky game of “musical chairs,” and the lack of candidates has had positive effects on the economy. This acute labor shortage may have shielded employment from the negative impacts of higher interest rates, causing companies to retain their talent. Additionally, this worker shortage has driven wage growth, resulting in higher disposable income and consequently stimulating the economy.
5. Housing scarcity prevented a collapse in the real estate market. The real estate sector often feels the potential adverse effects of higher interest rates first. However, this sector remains active, which is good news for the overall economy. Given its significance, this dynamic has been beneficial. Despite elevated interest rates making home purchases more challenging, the significant housing shortage has kept prices stable. Experienced sellers have exacerbated the supply issue, but this resilience in the real estate market has been a vital support for the economy, even with the average 30-year mortgage rate more than doubling from what it was two years ago.

Does this mean the US economy is out of danger?

Just a few months ago, the idea of the Federal Reserve (Fed) achieving a ‘soft landing’ (i.e., raising interest rates just enough to contain inflation but without causing a recession) seemed nearly impossible. Now, it’s the most likely forecast among economists. With inflation stabilizing and falling to 3% in June, not far from the long-term target of 2%, the Fed can achieve an extended pause for further rate hikes. While these elevated rates continue to ripple through the economy, it’s possible that inflation could further decline (slightly above 2% might still be acceptable) without a sharp economic slowdown. If a downturn were to appear too abrupt, the Fed has its rate-cutting tools at its disposal – and investors are already betting on that happening next year.

However, a cautious alert should be sounded against celebrating too early. Despite the growing chances of a soft landing, there are still obstacles ahead.

The first is a potential resurgence of inflation, which could make it challenging for the Fed to lower interest rates or worse, force it to raise them further. The easier part of the inflation’s downward trajectory is behind us; what follows might be more complicated. Commodity prices are holding steady, and persistent inflation in the service sector remains visible. An uptick in economic activity could exacerbate these issues, catching the market off-guard.

The second obstacle is an abrupt growth slowdown, which might happen later than anticipated. The effects of rising interest rates are complex and unpredictable, both in terms of timing and magnitude. The pandemic has only made deciphering the signals more challenging. While the economy has remained resilient so far, it’s possible that the discussed factors have merely postponed economic challenges to the future rather than eliminating them entirely. The longer interest rates remain high, the higher the risk of financial instability or a late-stage growth shock. It wouldn’t be the first time that higher interest rates change the game in the long run, turning what seemed like a soft landing into an exceptionally complex situation. Remember that the Fed has achieved a soft landing only once in its history.

Therefore, the macroeconomic outlook now points to sunnier days compared to a few months ago, offering reasons for optimism. However, I would still recommend keeping an umbrella handy. Even when the short-term forecast is clear, a storm can unexpectedly arise.

So, essentially, it’s good to maintain optimism, but with caution. Exactly. And remember: in times like these, it’s not a bad idea to broaden your investment horizons. That way, you can still hold US technology stocks but also consider investing in different sectors (including defensive havens like consumer staples and healthcare), regions (European stocks, emerging markets, and Japan can help diversify risk), and asset classes (gold and Treasury bonds tend to perform well in slowdowns, while other commodities might be poised for an uptick if growth remains steady). Additionally, as always, having a portion of your wealth in cash (which, this time, offers high yields) can provide an edge for seizing opportunities in an environment that might become more turbulent, resembling a rollercoaster.

Ultimately, wise investing isn’t about predicting the future – it’s about ensuring your portfolio can withstand a variety of scenarios, even those your crystal ball doesn’t foresee.

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