For months, economists have struggled with the disconnect between how well the economy is doing and how badly people feel about their financial situation.
Now, data shows that the so-called shock, or that prolonged period of negative sentiment about the economy, appears to be ending, according to Michael Pearce, deputy chief US economist at Oxford Economics.
As inflation cools and the Federal Reserve prepares to cut interest rates, Americans’ assessments of the future are improving, putting the country’s economic position more in line with consumer sentiment, Pearce wrote in a report released Friday.
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Other economists also note a recent glass-half-full outlook.
“Consumer confidence seems to be about the size of where the economy is,” said Brett House, an economics professor at Columbia Business School. “They kind of meet in the middle.”
However, it is difficult to pinpoint what causes the change in mood, Pearce wrote in his report.
“Our top candidates would be a delayed response to the news that inflation is easing and appears to be on a steady trend back to 2%,” Pearce wrote. “It could also reflect increased optimism about the future now that the Fed is on a clear path to cutting interest rates.”
Setting the stage for the Fed to cut interest rates
Recent economic data has paved the way for the central bank to cut its benchmark interest rate for the first time in years.
The personal consumer spending price index – the Fed’s preferred measure of inflation – rose 2.5% year-on-year in July. And, although the unemployment rate is still low at 4.2%, it has risen over the past year.
“All signs point to continued progress in inflation, with pressures expected to ease further with the release of the August consumer price index on Wednesday,” said Greg McBride, chief financial analyst at Bankrate.com.
“Other measures of inflation – the personal consumption expenditure index and unit labor costs – tell the same story and set the stage for the Federal Reserve to start cutting interest rates this month,” he said.
Markets are now pricing in a 100% chance the Fed will begin cutting interest rates when it meets Sept. 17-18, with the potential for more aggressive moves later in the year, according to CME Group’s FedWatch gauge.
“Nailing a long-awaited soft landing”
Meanwhile, consumer spending held up even better than expected, according to the latest reading.
“The American consumer has been resilient,” said Jack Kleinhenz, chief economist at the National Retail Federation, in the NRF’s September issue. Monthly Economic Reviewwhich was released on Friday
Despite earlier expectations of a recession, the US has avoided a recession, according to Kleinhenz.
“The U.S. economy is clearly not in recession, nor is it likely to go into recession inside 2024,” Kleinhenz said. “Instead, the economy appears to be on the verge of nailing down a long-awaited soft landing with a simultaneous cooling of growth and inflation.”
Progress in inflation without a significant deterioration in the labor market has created a “classic Goldilocks scenario,” Columbia House said.
Although as CNBC’s Bob Pisani put it recently, there is still a group of “musts” who insist a serious slowdown is coming. And yet, fewer economists now see that happening in the near future. Goldman Sachs recently cut the probability of an economic downturn from 25% to 20%, shortly after raising it from 15%.
“This cluster was very crowded in 2023 and for good reason, but the chances of a soft landing have continued to increase over the past 12 months,” McBride said.
Officially, the National Bureau of Economic Research defines recession as “a significant decline in economic activity that is spread throughout the economy and lasts more than a few months.” The last time it happened was in early 2020, when the economy was in a tailspin.
In the past century, there have been more than a dozen recessions, some lasting as long as a year and a half.
“The recession fans will be right after all”
“The problem with recession fans is, of course, they’re always going to be right at some point,” House said. “It is certainly the case that, at some point in the future, the U.S. economy will sink into a recession.”
Since the fall of the Berlin Wall, some sort of economic disruption or correction has occurred with fairly predictable regularity, according to House. Now there is the added uncertainty of the upcoming US presidential election and the prospect of major policy changes.
“The recession fans will be right in the end,” House said, but “there is no victory if it comes in a few years.”
