FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
August 29, 2023

Fed Says Economy Heating Up Big-Time In 3Q

IN THIS ISSUE:

1. Fed Says GDP Soaring A Whopping 5.8% Rate In 3Q

2. Most Forecasters Dead Wrong About Economy In 2023

3. Inflation Down From 2022 Peak, But Still Very High

4. 30-Year Mortgage Rates Surge To 23-Year High Above 7%

Overview: Fed Says GDP Soaring A Whopping 5.8% Rate In 3Q

The US economy as measured by Gross Domestic Product had a decent first half of the year, with GDP increasing at an annual rate of 2.4% in the 1Q and 2.0% in the 2Q. Yet according to the latest estimate from the Atlanta Fed, the economy has soared higher so far in the 3Q.

The Atlanta Fed’s latest GDPNow indicator is showing the economy has soared at a whopping annual rate of 5.8% so far in the 3Q. Frankly, that is hard to believe and it is far above most forecasters’ current estimates for GDP growth in the 3Q.

As you can see above, the latest GDPNow reading shows the economy shot higher so far in the 3Q to an annual rate of 5.8%, which is a huge jump from the 2.0% estimate for the 2Q. As you can also see, the Fed’s latest estimate is considerably higher than that of the Blue Chip Consensus estimate of America’s leading business economists – which is still below 2%.

Most forecasters doubt the 5.8% figure will hold up as more economic reports come in for the 3Q, which doesn’t end until September 29. I agree – I will be shocked if the final number is nearly as high as 5.8%. The Fed’s weekly GDPNow estimate is based on the latest economic data the Fed has seen so far this quarter, and it is what it is, at least for now.

If the 5.8% preliminary estimate holds, it would be the strongest quarter of economic growth since 2003, and it would mean economic growth nearly tripled from the 2% rate in the 2Q. Obviously, that’s a little hard to believe, but as noted above there is a good chance the Fed will revise its GDPNow estimate lower in the weeks just ahead.

Most Forecasters Were Dead Wrong About The Economy In 2023

Even if the latest 5.8% estimate of 3Q GDP is revised lower, it will still be a strong number. And it will be yet another indication that a recession is not likely later this year. If you recall, most forecasters came into 2023 with decidedly lower estimates for GDP growth this year. Most predicted GDP growth would slow significantly from the 2.1% rate in 2022.

More importantly, many leading forecasters predicted a recession in the second half of this year. As regular readers will recall, I never bought into that ultra-negative outlook, and I even argued that a recession was NOT the most likely scenario for this year.

As this is written, many bearish forecasters are now softening their previous predictions for a recession this year. Some are now saying instead of a recession in the last half of this year, they now expect a so-called “soft landing” where economic growth still slows down to near zero but we avoid a recession.

I have maintained all year that the recession scenario was not the most likely outcome for 2023. I look at consumer spending patterns since consumer spending accounts for apprx. 70% of GDP. And consumer spending remains firm this year, despite higher inflation concerns.

Not only has consumer spending not gone down this year, it has continued to rise despite widespread concerns about inflation, as you can see at left. I see nothing on the near-term horizon to change that.

While most Americans do not believe the economy is remotely as strong as President Biden would like us to believe, they don’t seem to fear that a recession is just around the corner. Neither do I.

As noted above, I really doubt that growth was 5.8% in the 3Q, and it will almost certainly be revised lower just ahead. However, even if that number turns out to be just 3%-4%, 2023 is turning out to be so much better than most forecasters were predicting coming into this year.

The bottom line is: the recession scenario for this year is now off the table. But as usual, most forecasters are reluctant to admit they got it all wrong. Nothing new about that.

Inflation Down From 2022 Peak, But Still Very High

US inflation as measured by the Consumer Price Index (CPI) rose at an annual rate of 3.2% in July. The “core” CPI – minus food and energy – rose at an annual rate of 4.7% last month.

Much of the monthly inflation increase came from shelter costs, which were up 7.7% from a year ago. Rents rose by a similar amount. The Commerce Department said more than 90% of the increase came from the shelter category, which accounts for about one-third of the overall CPI weighting.

Food prices climbed 4.9% in the year ended July, and the latest report said energy increased just 0.1% even though crude oil prices surged during the month and prices at the pump jumped as well. However, for the year ended July, energy prices are significantly lower thanks largely to the drop in crude oil prices since the peak in 2022.

Used vehicle prices declined 1.3% and medical care services were off 0.4%. Airline fares fell 8.1% on the month, the same as in June, and are down 18.6% from a year ago after surging in the early days of the Covid pandemic.

So, while inflation has come down considerably from the peak in mid-2022, it remains well above the Fed’s target of 2%. The question, as always, is where does inflation go from here?

The answer is, much depends on the economy. As discussed above, the Fed now estimates that GDP has risen at an annual rate of 5.8% so far in the 3Q. If that estimate holds up, this means the economy has heated up significantly, and inflation almost certainly doesn’t go any lower.

Even if the next Fed estimate of 3Q GDP is revised lower, say to 3%-4%, that would still indicate the economy is strengthening, and inflation probably won’t go much lower in this cycle. But will it reverse course and begin to trend higher again?

A look at the latest price action in gold and silver – two inflation-sensitive commodities – might be instructive. Both gold and silver remain within their recent trading ranges as this is written. This suggests that precious metals are not expecting a big rise in inflation just ahead.

According to the latest report from the New York Fed, US consumers are not worried about another sharp rise in inflation either. Inflation expectations for the year ahead fell for a fourth consecutive month to 3.5% in July of 2023, a fresh low since April of 2021.

Of course, consumer inflation expectations are not always correct. Few Americans expected used car prices to explode in 2020 and 2021. Likewise, almost no one expected inflation to soar above 9% as it did last year in June. In any case, the chart above suggests most consumers expect inflation to hold relatively steady over the next year. We’ll see.

30-Year Mortgage Rates Surge To 23-Year High Above 7%

The average interest rate on a 30-year fixed mortgage rose above 7% earlier this month, the highest level since 2000. That’s up significantly since the recent low near 3% in 2021.

As borrowing costs surged, home sales tumbled all last year and a hoped-for recovery this year has yet to materialize. Case in point: Sales of previously owned homes, which account for the majority of US residential real estate transactions, fell for a second month in July to the lowest pace since January.

The Mortgage Bankers Association data does not point to improvement any time soon. Its index measuring applications for a mortgage for a home purchase sank 5% last week to the lowest since April 1995. It was the largest weekly decline since April.

Surprisingly, higher mortgage rates have not significantly slowed sales of new homes. New home sales rose in July from the month before, beating estimates and reaching a 17-month high, as buyers continue to look to new construction as an option in the face of a historically low supply of existing homes.

Sales of newly constructed homes rose by 4.4% in July to a seasonally adjusted annual rate of 714,000 units from a downwardly revised rate of 684,000 in June, according to the latest report from the US Department of Housing and Urban Development and the Census Bureau. Sales were up 31.5% from a year ago.

That’s huge and well above expectations, especially considering that sales of existing homes were 16.6% lower compared with July of last year. Previously owned homes sold at the slowest July pace since 2010.

While higher mortgage rates are a factor, the National Association of Realtors blames tight supply for most of the decrease. There were 1.11 million homes for sale at the end of July, 14.6% fewer than July 2022 and the lowest level since 1999. There are now half as many homes for sale as there were pre-Covid.

Short supply continues to push both competition and prices higher. The median price of a home sold in July was $406,700, an increase of 1.9% from July of last year. Soaring home prices are another big reason why owning a home is now out of reach for many middle-class Americans.

I’ll leave it there for today. I hope everyone had a great summer!

Best personal regards,

Gary D. Halbert

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