Recently released data indicates that the U.S. economy grew at a 2.6% rate in the third quarter of this year. That data follows negative growth in both the first and second quarters. If the relatively strong growth continues, the U.S. will avoid a recession.
Paul Ashworth, chief North American economist at Capital Economics says, “Overall, while the 2.6% rebound in the third quarter more than reversed the decline in the first half of the year, we don’t expect this strength to be sustained. Exports will soon fade, and domestic demand is getting crushed under the weight of higher interest rates. We expect the economy to enter a mild recession in the first half of next year.”
Much of the growth in gross domestic product (GDP) was due to exports increasing and imports decreasing. That will not continue because as the Federal Reserve continues to raise interest rates, foreign capital is attracted to the U.S. That increases the demand for dollars and makes the dollar more expensive versus foreign currencies.
That means our exports will become more expensive and our imports will become less expensive. That will lead to a reduction in exports and an increase in imports. That will then reduce future GDP, as exports add to GDP while imports subtract from it.
Consumer spending rose just 0.4%, lower than the 0.5% recorded in the second quarter. Consumer spending accounts for almost 70% of GDP. With inflation continuing to result in negative growth in real wages, spending by consumers is likely to decline in the near future. That also will slow future growth in GDP.
The Federal Reserve will continue to raise interest rates to reduce inflation. With rising energy and food prices that the economy is currently experiencing, the Fed will raise interest rates another 75 basis points next week.
The better-than-expected third quarter GDP growth number may mean that the reluctance to raise rates too fast and slow the economy, may be reduced. That could mean another 75-basis point rate increase in December.
Already, the high interest rates are reducing demand for interest rate sensitive products. Existing home sales are declining, having fallen for seven straight months. Mortgage rates have reached 7%, and with the coming Fed rate increases, mortgage rates will reach 8% by early next year. That will significantly reduce the demand for houses.
There is, however, some positive data about inflation in the third quarter. The Personal Consumption Expenditure (PCE) increased 4.6%. This is the inflation measure the Federal Reserve watches closely. In the second quarter, the PCE increased by a whopping 7.3%.
Much of that decline is due to the temporary fall of energy prices. After gasoline peaked at a national average of $5 per gallon in June, prices fell 5% in July, another 10% in August and another 5% in September. In October, gasoline prices started to increase.
Since OPEC is determined to raise the price of oil and since the U.S. is now producing more than a million gallons per day less than production at its peak, oil and gas prices will continue to rise.
Food prices will see larger increases in the fourth quarter. That’s because farmers will demand more for their crops this year’s harvest due to the rising cost for farmers. This is because fertilizer cost has doubled, or even tripled in some cases. Farmers also experienced higher labor costs because of the labor shortage. And since all their equipment uses diesel fuel, energy costs are much higher for them than in prior years.
Add in the wheat and grain shortages because 25% of the world’s wheat supply comes from Russia and the Ukraine, and food inflation will worsen.
While the third quarter positive GDP growth number is certainly welcomed, this growth rate will not continue. It looks like the negative growth will return perhaps in the fourth quarter, but more likely in the first and second quarters of next year. That means a recession in 2024.