American exceptionalism

American exceptionalism

The US economy has had a good year. Not only has it evaded a widely expected recession, but growth has also accelerated and the inflation rate has halved. The US economy looks likely to grow by 2.5% this year against expectations in January of just 0.2%. Corporate profit margins are rising and almost 80% of US corporates, which have reported their latest results, have exceeded market expectations. Anyone who defied the gloom and bought US equities at the start of the year would have seen a gain of 17%.

• Instead of slowing in the face of the biggest tightening of US monetary policy in 40 years, growth has accelerated even as growth in Europe grinds to a halt. How can we explain this exceptionalism?

• Part of the reason relates to the structure of US debt. US homeowners are insulated from the immediate effect of higher rates by holding 30-year fixed-rate mortgages. Only when they move, and refinance, do households feel the effect of higher mortgage rates. Corporates, especially larger ones, are increasingly insulated from the immediate effects of higher rates. In recent years, many US corporates have protected themselves against the risk of rising rates by borrowing at long-term fixed rates. High levels of consumer savings and corporate cash built up in the pandemic have also helped support growth, as has a loose fiscal policy, with the Federal government running a sizeable deficit, equivalent to around 6% of GDP. The fact that the US was not dependent on Russian natural gas, and was, in any case, a relatively light user of gas, meant that last year’s energy crisis had less impact in the US than Europe.

• There is no doubt, 2023 was a remarkable year for the US economy. The question is whether the good news will continue. This is where it gets murky.

• I was on a call earlier this month where a senior US policymaker said that it was possible to imagine that the US economy would continue to post good growth in 2024, or slow – or go into recession! The comment was not flippant. Views on the US outlook vary widely, going from ‘soft landing’ at one end to recession at the other.

• The Economist magazine put the case for recession earlier this month. It argues that once US consumers exhaust their savings the effects of higher interest rates will start to bite, manifesting in falling house prices and higher unemployment. Weaker consumer spending will hit corporate revenues, pushing up bankruptcy rates. Banks holding long-term securities will come under pressure as they “have to raise capital or merge to plug the holes blown in their balance sheets by higher rates”. Higher rates will also force the government to cut back on borrowing, ending the easy fiscal policy that has bolstered growth. For The Economist, the recession has been delayed, not cancelled.

• Most economists share these concerns but have become more optimistic that the US will avoid a recession. Those surveyed by The Wall Street Journal in October put the probability of a US recession in the next 12 months at 48%, the first time in over a year that the probability has dropped below 50%. The central view for most economists is of weaker, but continuing growth.

• Deloitte’s US economist, Danny Bachman, was optimistic on the US earlier this year and has been amply vindicated by events. Danny’s central view now is that US growth will slow slightly next year, from about 2.5% to just under 2.0%.

• The US economy faces two opposing forces in 2024. On the one side, the lagged effects of raising interest rates by over 500bp are still feeding through the system. That speaks to higher credit costs, problems for more indebted corporates and consumers and higher unemployment to come. The opposing force comes in the form of lower inflation that will support spending power and corporate margins.

• History shows that soft landings for economies are rare. Major inflationary episodes are classic harbingers of recession. The US has defied that narrative this year. It has a fair chance of doing so next year too.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index closed the week up 2.0% at 7,504, boosted by falling inflation and a decline in investors’ interest rate expectations

Economics

• UK inflation fell to 4.6% in October, down from 6.7% the month before, driven in part by a reduction in Ofgem’s energy price cap but also by a slowdown in services inflation, which is seen as a good gauge of underlying price pressures
• UK regular annual pay growth moderated slightly to 7.7% between July and September. Despite the moderation, falling inflation meant real wages increased over the period by the biggest margin for two years
• The UK labour market showed further signs of a gradual softening as the number of vacancies continued to fall in the three months to October, despite the unemployment rate holding steady at 4.2%
• The volume of UK retail sales fell by 0.3% in October from the previous month to the lowest level since early 2021 when large parts of the country were in lockdown as households struggle with rising living costs
• US inflation fell more than expected in October to 3.2% from 3.7% in September. Treasury yields fell sharply on the news as markets anticipated a slightly lower interest rate path
• US producer prices declined by 0.5% in October, the sharpest fall since April 2020, driven by lower gasoline prices
• US retail sales fell only marginally last month, defying predictions of a larger decline as higher interest rates weaken demand. The data added weight to the view that the US economy is heading for a gradual slowdown rather than a sharp contraction
• Chinese industrial activity and consumer spending both rose more than expected in October signalling positive momentum as the economy struggles with several headwinds
• Rabobank, a major lender to agricultural businesses, expects global food prices to fall sharply next year after several years of elevated prices due to increased supply and weaker demand
• UK building society Nationwide’s chief executive Debbie Crosbie said mortgage arrears will continue to creep up, but it will be “nothing as severe as we would have thought this time last year”
• 58% of UK low-income households with a mortgage have fallen behind on one or more of their bills, and three quarters are going without essentials due to pressure on their finances from the rising cost of living, according to a survey from the Joseph Rowntree Foundation
• Italy banned the production, sale or import of lab-grown meat after lobbying from farmers in what the government described a defence of Italian tradition

Business

• Sam Altman, CEO of OpenAI, the technology firm behind ChatGPT, was fired by the board which it said had lost confidence in his ability to lead the company
• The share price of US retail firm Walmart fell 8% after the company said that it had noted a softening of demand in October as consumers are pressured by higher living costs
• The UK government raised the price paid to offshore windfarms developers by more than 50% as the costs of rising inflation and interest rates meant the previous auction prices were too low to make new schemes viable
• UK fuel stations will be required to disclose profits or face hefty fines from next year after the Competition and Markets Authority voiced concerns that competition is not working to hold down prices at the pump
• Credit ratings agency S&P found that oil and gas companies face almost no extra borrowing costs compared with less polluting companies, showing that “environmental concerns seem to be far from the most important factor for funding oil and gas companies”, the FT reports
• Industrial technology group Siemens warned of slowing demand for its products over the next year owing to flat growth in China even as it reported record profit margins in the previous fiscal year ending in September
• Elon Musk’s Space X’s Starship rocket reached space for the first time but self-destructed during its flight

Global and political developments

• UK prime minister Rishi Sunak made several changes to his cabinet, including ousting Suella Braverman as home secretary who is replaced by former foreign secretary James Cleverly, and the return of former prime minister David Cameron as foreign secretary
• UK chancellor Jeremy Hunt is considering cutting inheritance and business taxes at this week’s Autumn Statement, the BBC reports
• The US president Joe Biden and China’s president Xi Jinping agreed to resume high-level military communication after meeting for the first time since late last year
• China’s biggest state-run newspaper called the meeting a “new starting point” for China-US relations while president Biden said: "We're back to direct, open, clear communications"
• The Western-led price cap on Russian oil exports has been ineffective as almost none of the sea-borne crude oil leaving Russia was below the $60/b limit in October, according to a senior European government official
• The US targeted three shipowners based in the UAE with sanctions for exporting Russian crude oil above the $60 price cap

And finally… a rare bottle of whisky was sold for a record breaking $2.7m at auction by Sotheby’s last week, more than double its estimated price. The Macallan 1926 single malt spent 60 years maturing in dark oak sherry casks before being one of just 50 bottled in 1986 – old fashioned