A Year for the Contrarian Growthers
The American economy can stay solvent longer than economists and pundits can stay irrational.
A year ago, virtually everyone was convinced that we were headed into a recession. Perhaps the apogee of the doomcasts came from Bloomberg Economics, which announced on October 17, 2022, that there was a 100 percent certainty of a recession within the next twelve months.
“A US recession is effectively certain in the next 12 months in new Bloomberg Economics model projections, a blow to President Joe Biden’s economic messaging ahead of the November midterms,” the article stated.
That sentence is particularly gratifying because it now seems doubly wrong. Biden’s Democrats outperformed historical precedents for a president’s first midterm election, surrendering only a slight majority to Republicans in the House of Representatives and just barely keeping control of the U.S. Senate. This was all the more impressive because the U.S. economy contracted for two quarters in the start of 2022 and experienced the worst recession in four decades.
We do not mean to pick on Bloomberg’s economics team. Economists up and down Wall Street were also calling for a recession. The Federal Reserve’s projections appeared to assume that a recession would hit sometime this year. Even as late as April, the consensus among analysts was that growth would turn negative or, at best, eek out a small gain in the third and fourth quarters of this year.
Even this page was too pessimistic late last year. We only changed our tune when the economic data for January began to show that instead of a hard or soft landing, the U.S. economy appeared to be headed for a “no landing” scenario in which growth and inflation remained high. “Retail Sales, Industrial Production, and Homebuilder Confidence Scream ‘No Landing,’” we explained in this space on February 15 of this year.
“There is no sign of a soft or hard landing in the data. In fact, it all suggests that demand remains strong. Even demand for consumer goods, which was supposed to be declining, seems to be on the uptick. The data this week — including the acceleration of consumer prices — all scream ‘no landing,'” we wrote.
A few days earlier, we had observed:
The strength of the labor market is giving rise to the idea that instead of a “soft landing” or a “hard landing,” the economy may be on track for “no landing” at all. That is to say, the long-awaited and much-heralded recession may not be looming in our near future—but that also means that inflation will not be coming down either…
This is definitely still a contrarian take. Right now the market expects the Fed to pause after two more hikes, with the Fed’s interest rate target in the five percent to 5.25 percent range. That’s actually a bit more hawkish than the previous consensus view, which had the Fed pausing after the March hike. The market reluctantly gave that up after the Fed statement and several Fed speakers made it clear after the February meeting that the economic situation was still calling for more hikes, which is to say more than one.
Yet the notion of a third hike, which would come at the June meeting, is no longer seen as outlandish. A month ago, the market was assigning the likelihood of three more hikes just a 10 percent chance. Today, the odds implied by the fed funds futures for three more hikes are over 40 percent.
The contrarian view turned out to be right. The economy did continue to grow, the labor market stayed strong, consumer spending stayed robust, and the Fed hiked a lot more than the consensus was forecasting back in the start of the year.
Our friend Larry Kudlow put us on his Fox Business show around this time to defend our view. You can watch it here.
“I looked at these numbers combined with the employment number—half a million jobs in January. We saw an 8.7 percent rise in Social Security benefits because of the cost of living adjustments. And so, people had a lot more money in January. I don’t see that going away,” we told Kudlow. “So, I’m worried that actually the Fed is going to have to go a lot higher than the five and a quarter [rate hike] people have been expecting. I’m looking at five and a half to six percent. I think they have to keep raising unless we get a bad number sometime between now and this summer.”
So, how did we do? The benchmark target is now a range of 5.25 percent to 5.50 percent. It is likely going up another quarter of a point before the end of year.
More Treats Than Tricks: The Third Quarter GDP Report
This amble down the avenues of anamnesis was prompted by the Commerce Department’s report Thursday on third-quarter gross domestic product. This showed the economy grew at an annual pace of 4.9 percent in the July through September period, after adjusting for seasonality and inflation. In nominal terms, the economy grew at an 8.5 percent annual rate.
The strength of the job market, rising asset prices, and still-plentiful stimulus-boosted savings appear to have given consumers the confidence to spend freely. Consumer spending rose at an annual rate of four percent in the third quarter, an impressive acceleration from the 0.8 percent gain recorded in the second quarter.
A lot of analysis is pointing out that this is the best growth in two years. What makes the third quarter’s growth even more impressive, however, is that it was not a rebound from a recession, a war, or a locked-down economy. Instead, growth in consumer spending persisted and accelerated organically.
It’s not a perfect report. “War Keynesianism” played a role in boosting growth, with federal defense spending up eight percent. Federal non-defense and local government spending were both up by around four percent. The federal deficit, of course, was much larger than expected, adding unwanted stimulus to an economy already at full-employment.
Nonresidential fixed investment, a key measure of business confidence, contracted 0.1 percent. Although that might be payback for the unsustainable boom in manufacturing structures that boosted nonresidential investment growth to 7.4 percent in the prior quarter, it is also likely a sign the business investment may be leveling off in reaction to higher borrowing costs and higher hurdle rates.
But those are not fatal flaws in the report and only undermine the growth picture at the edges. One of our favorite measures of private sector demand is recorded as “final sales to private domestic purchasers.” This was up 3.3 percent in the third quarter, a very strong indication that the growth recorded in GDP is deep and significant.
The consensus now says that the kind of growth we have seen so far this year will not last. The economy is expected to slow in the months ahead as the Fed keeps interest rates more or less steady. Growth is seen as turning anemic by mid-year, giving the Fed reason to cut rates in late spring or early summer.
While growth will come down from the 4.9 percent rate recorded in the third quarter, the forecasts for next year seem overly pessimistic about the prospects for growth (and too optimistic about the prospects for disinflation). In short, we see little reason to suspect the current consensus is any more reasonable than the old consensus.
