Where is the economy headed?
The litany of risks to the global economy are manyfold: Federal Reserve tightening of the money supply, ongoing supply chain disruptions, persistent inflation, the lingering effects of the pandemic and a war in Ukraine. In response, the economic system seems to be a bit schizophrenic. The statistics are all over the board.
Nationally, the economic recovery from COVID slowed in the first quarter of 2022. Total GDP fell by -1.6% reflecting an upsurge in COVID infections and the tapering of government stimulus. Growth in the Tennessee likewise fell (-1.3%). There has been some recovery in the past few months.
Conversely, personal income increased. Tennessee saw robust growth of 5.8% early in the year. Personal spending increased commensurately. This reflects the (still) lingering impact of past stimulus and somewhat higher wages needed to induce people back into the labor market.
Inflation (formerly called “transient” by the Biden Administration) has roared back. In the past year, the Consumer Price Index (CPI) increased +8.6 %, the largest 12-month increase in forty years. While a main driver has been the energy sector (+34.6%), the food index rose over ten percent.
Consequently, the Federal Reserve (Fed) has increased interest rates in an attempt to turn down the heat. After a 0.25% increase in March, the first since 2018, they have steadily increased rates to at each meeting (The most recent hike of +0.75% was the largest since 1994). The impact on mortgage rates has been dramatic. The 30-year average peaked in mid-June almost 3.5% percentage points above its August 2021 low of 2.89%. The current rate hovers around six percent.
In this mix is the very low unemployment rate of 3.6% in June nationally. In May, the Tri-cities figure was slightly better (3.4%), however, the regional Labor Participation Rate (measure of the number of people who have or are seeking a job versus the total potential workforce) is well below the national average (approximately ten percentage points less).
In short: People have higher incomes and there are not enough employees to fill job vacancies. We are spending more (albeit for more expensive goods). And the real estate market is still hot (despite mortgage rates doubling).
How do we explain the incongruities? What do these figures mean? More important, what does all of this portend for the future?
No one really knows how this will play out. The macro picture (nationally and internationally) and the local outlook are related, but not coincident. In the past, our region lagged the national recession in 2008. In fact, some people were lulled into believing “It won’t happen to us.” (Yes, it did. And yes, it will!)
If the economy is so constrained by worrisome factors why do some sectors seem to be blistering along? The easy answer is, “cash!” The Federal government has poured trillions of dollars in stimulus money into the economy (to both businesses and individuals) and those effects still linger. It will take time for this to work its way out of the system, which is one reason the rise in interest rates seems to have had limited effect (on spending and home-buying).
We haven’t yet felt the “hangover” from our binge, but things are starting to change. The Consumer Sentiment Index has dropped by over 40% in the past year to its lowest recorded level. Consumer spending generally follows their sentiment (typically delayed). Individuals will be stuck on the horns of a dilemma: either choose to continue spending or reduce expenditures in response to higher price. If they continue spending, it will negatively impact their financial position and make the Fed’s choices more difficult through the second half of this year. Decreased spending would slow the economy and increase the likelihood of a “recession.” Ah, there is that nasty word that no politician wants to invoke yet it is becoming ever more likely that it lies in our future.
If COVID-19 (and its variants) continue, particularly if China maintains its ‘COVID zero’ strategy (locking down segments of their economy), it is doubtful if the supply chain issues will be adequately resolved. The War in Ukraine will continue to create anxiety (negatively affecting consumer sentiment) and put further stress on the energy sector (particularly as winter approaches). Eventually, the “cash” will work its way out of the economy and higher interest rates will eventually take their toll (particularly on the real estate market). Ultimately, consumer spending will fall (there is only so long you can spend money you don’t have-unless you are the government).
The Administration now has precious few tools to combat recession in the near term (I am skeptical about the positive impact of any government action). The Fed can still play with interest rates (the recent hikes are likely an attempt to get some room to operate). Government stimulus could increase personal spending, but not if sentiment is low (people will hold back). Furthermore, at some point the government will lose its credibility. How long can the Administration hemorrhage money into the system? At what point do we question their (our) ability to pay it back (even a massive tax increase wouldn’t make a dent)?
A global and national recession seems inevitable (within the next year). The impact locally may be somewhat different. Much of the economic drivers to our region (particularly the housing market) are driven by external forces. Would a recession increase or decrease the exodus of people from high tax states? Further, older retirees are having a greater impact on the region. More than 900 residents turn 65 each year and 600 turn 70. Over 155 thousand residents draw Social Security. This sector is much less sensitive to economic fluctuations (but they are greatly impacted by higher inflation).
The optimist in me wants to believe in the “special nature” of our region. The realist is very cautious. In the end, “as goes the nation, so goes the local economy.”