US Weekly Economic Commentary: Below-trend growth this year amid stubborn inflation

Last week, we released our updated forecast for the US economy showing real GDP growth of 1.2% (measured year-over-year) in 2023, followed by growth of 0.9% in 2024. These figures were revised down, from 1.4% and 1.5% in last month's forecast, to reflect both a further assumed tightening of bank lending standards and growing concerns about adverse fallout as the debt limit becomes binding.

Our forecast narrative remains that a period of below-trend growth, and a rise in unemployment, are required to reduce inflation to the Fed's 2% objective over the next two years. We saw little new data last week to influence our expectation that real GDP will decline 0.1% in the second quarter. This is significantly below the Atlanta Fed's GDPNow estimate of 2.7% growth, which anticipates considerably stronger second-quarter growth in personal consumption expenditures (PCE) than do we. Some of this difference might be resolved with this week's release of data on retail sales for April.

In our favor, consumer sentiment slumped further in May, although recently the relationship between sentiment and PCE has been tenuous at best. At its May meeting, the Fed raised its policy rate to the range of 5.0% to 5.25% while maintaining a tightening bias pending data on the evolution of inflation pressures. Since then, the Bureau of Labor Statistics reported that employment grew firmly in April and that, even with the recent upward drift in unemployment claims, the unemployment rate fell to 3.4%, the lowest since the spring of 1969.

Meanwhile, last week's suite of data on prices for April suggested that inflation remains stubbornly elevated. The 12-month change in core consumer prices ticked down 0.1 percentage point to 5.5%, but has hovered in the range of 5.5% to 5.7% since December. Furthermore, for the second consecutive month, the 12-month change in the price of core consumer goods has moved up, from 1.0% in February to 2.0% in April, hinting that disinflation from the resolution of supply bottlenecks has run its course — a message reinforced by April's data on producer prices and the prices of imports and exports.

Our forecast shows the Fed's policy rate now at a cyclical peak, with a reversal in policy coming in March of next year. However, underscoring the upside risk to that forecast, Fed Governor Bowman, in a speech on Friday in Frankfurt, remarked "should inflation remain high and the labor market remain tight, additional monetary policy tightening will likely be appropriate to attain a sufficiently restrictive stance of monetary policy to lower inflation over time."

Headwinds from credit tightening

While the financial turmoil that immediately followed the failure of Silicon Valley Bank (SVB) in early March has subsided, a resulting tightening of credit is widely expected to generate headwinds for the economy as this year wears on. The Fed released its April survey of senior loan officers on bank lending practices which showed, since the January survey, a tightening of standards on all categories of loans. The responses were collected between March 27 and April 7 — too early, we think, to reflect the full fallout from the demise of SVB. Indeed, special questions in the survey revealed that lending officers anticipate tightening standards further over the rest of the year. Other special questions highlighted the Fed's concern over the ramifications of a potential deterioration in the quality of commercial real estate loans.

Our base forecast reflects an estimate that constraints on the availability of credit will shave about 0.25 percentage point from GDP growth over the remainder of this year. Most recent weekly data, from the Fed's May 12 H8 release survey, show deposit outflows have stabilized and that loan volumes, while slowing, are still expanding. The latest estimates — from both Treasury and CBO — are that the US may fail to meet all its financial obligations before an expected mid-June surge in quarterly tax payments. House Democrats are preparing a longshot discharge petition to advance a clean debt limit bill, and President Biden hinted he's considered a legally untested constitutional end run around the debt limit. In the end, however, resolution of the fiscal impasse most likely will rest on the outcome of ongoing negotiations that, to date, have yielded little progress.

Meanwhile, related strains are emerging in financial markets. The rates on Treasury credit default swaps are spiking, suggesting priced odds of a true sovereign default in the low single digits and implying higher odds than that of a technical default during which some payments — other than debt service — are delayed. The yield on Treasury notes coming due within a month has soared towards 6%. In a letter to Treasury Secretary Yellen, the Treasury Borrowing Advisory Committee warned that the consequences of a default are "unquantifiable" and "unthinkable."

The stock market remains sanguine about the situation but, in 2011, it was not until just days before "X-day" that equity prices quickly skidded nearly 20%. Our base forecast assumes that even a technical default is avoided, but an increase in financial turbulence as X-day approaches is a headwind that shaves 0.5 percentage point from GDP growth over the following year.

This week's economic releases:

• Retail and food services sales (May 16): We estimate total retail and food services sales rose 0.7% in April, while excluding motor vehicle and parts dealers, sales rose 0.5%. Both figures would follow declines over February and March. Readings on retail sales since last October have been buffeted, to an unknown degree, by shifting seasonal patterns for spending and unusual weather.
• Industrial production (May 16)
• Housing starts (May 17): We estimate the annualized pace of private housing starts declined in April to 1,388 thousand from 1,420 thousand in March. This would leave them in line with recent averages and support the view that housing has reached a bottom.
• Existing home sales (May 18): We estimate the annualized pace of existing home sales declined in April to 4,335 thousand. This would be the second monthly decline following a huge, 13.8% increase in February and would leave the pace of sales still significantly higher than that of January.
• Conference Board's Leading Economic Index (May 18): A decline would continue a trend that began in April 2022. In the history of the LEI, which dates back to 1959, there has never been such a decline as we've seen over the last year or so that was not associated with a recession. This, of course, raises the risk of a recession beginning at some point in the near future.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.