US economy showed momentum at year’s end, defying recession fears

The economy remained resilient last year in the face of inflation, war and a Federal Reserve intent on curbing the pace of growth. A repeat performance in 2023 is far from guaranteed.

US gross domestic product, when adjusted for inflation, increased at an annual rate of 2.9 per cent in the fourth quarter of 2022, the Commerce Department said on Thursday (Jan 26).

That was down from 3.2 per cent in the third quarter but nonetheless represented a solid end to a topsy-turvy year in which the economy contracted in the first six months, prompting talk of a recession, only to rebound in the second half.

Beneath the quarterly ups and downs is a simpler story, economists said. The recovery from the pandemic recession has slowed compared with the frenetic pace of 2021, but it has retained momentum thanks to a red-hot job market and trillions of dollars in pent-up savings that allowed Americans to weather rapidly rising prices.

Over the year as a whole, as measured from the fourth quarter a year earlier, GDP grew 1 per cent, down sharply from 5.7 per cent growth in 2021.

“2020 was the pandemic; 2021 was the bounceback from the pandemic; 2022 was a transition year,” said Jay Bryson, chief economist for Wells Fargo.

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The question is, a transition to what? Bryson, like many economists, expects a recession to begin sometime this year, as the effects of higher interest rates ripple through the economy.

The initial rebound from the pandemic recession was much stronger in the United States than it was in much of the rest of the world. The gap widened last year as the war in Ukraine threatened to push Europe into a recession and the strict Covid-19 suppression policies in China constrained growth there.

But the US economy faces fresh challenges in 2023. Inflation remains too high by many measures, and the Fed is expected to continue increasing rates in an effort to bring prices under control. A congressional showdown over raising the debt ceiling could cause further turmoil in financial markets — or a crisis if lawmakers fail to reach a deal.

Already, there are signs of strain, especially in the sectors most sensitive to higher borrowing costs. Construction activity and home sales have slowed significantly. Tech companies have announced tens of thousands of layoffs in recent weeks. Manufacturing output fell in November and December.

Still, in the consumer-driven US economy, a recession is all but impossible as long as households keep opening their wallets. So far, they have done so.

Consumer spending rose at a 2.1 per cent rate in the fourth quarter, down only slightly from the third-quarter pace. Americans have proved particularly willing to shell out for vacations, restaurant meals and other services that they had to forgo earlier in the pandemic. Luxury spending, too, has remained strong, buoyed by higher-income consumers who are less affected by inflation.

“Housing is in a recession, manufacturing is slowing, but if the consumer keeps spending, you’re not going to get a recession,” said Michael Gapen, chief US economist at Bank of America.

David Bellman, who owns a jewellery store in New Hampshire, saw his business boom early in the pandemic, when customers took the money they would have spent on vacations and bought jewellery instead. He expected sales to dip last year as the economy reopened, but they never did.

“I said, this year there’s no way we could beat the numbers from 2021, and we did,” he said.

For the economy, that willingness to spend is a source of strength, but also of trouble. The Fed is trying to tamp down spending in an effort to control inflation. If consumers don’t pull back, policymakers may feel the need to be more aggressive, increasing the risk that they will go too far and push the economy into a recession.

“Resilience is a good thing in many ways, but it’s also something that makes things harder for the Federal Reserve and it hardens their resolve,” said Diane Swonk, chief economist at KPMG, an accounting firm.

There are some hints that consumers may at last be reaching their limits. Americans in recent months have been saving less and using credit cards more as pandemic-era savings dry up. Retail sales have fallen for two straight months, and a big buildup of inventories in the fourth quarter suggests that many businesses may have sold less during the holiday season than they expected.

“You can start to see the cracks here,” said Brett Ryan, senior economist at Deutsche Bank.

In some corners of the economy, those cracks are more like fissures. Housing, in particular, has been battered by rapidly rising interest rates. Residential construction activity contracted at an annual rate of 26.7 per cent in the fourth quarter, capping its worst year since the subprime mortgage crisis 15 years ago. It was a striking reversal from earlier in the pandemic, when home building was booming.

The labour market remains the clearest source of optimism in the economy. Despite high-profile job cuts in tech, there has been no significant increase in layoffs more broadly, and the unemployment rate remains at a half-century low. Government data next week is expected to show that employers continued adding jobs in January.

Inflation, meanwhile, has been easing. That could allow the Fed to raise rates more slowly, reducing the risk that it will go too far in cooling off the economy.

“We have seen good news on inflation even with the labor market staying strong,” said Wendy Edelberg, director of the Hamilton Project, an economic policy arm of the Brookings Institution. “Now monetary policy can be a little more patient.” NYTIMES