Unexpected prosperity observed in the U.S., reducing recession outlook
Deepening fiscal deficits and concerns spreading amid high-interest rates
Rising delinquency rates among American youth, negatively impacting consumption
Inflation in October is on the rise, and the “hawkish Fed” stance persists
Despite global high-interest rates, the U.S. economy, which has been enjoying a ‘lone boom’, is increasingly predicted to enter a downturn. The massive fiscal expenditures and employment and consumption indicators propping up the U.S. economy are beginning to show cracks. Although the U.S. inflation rate is currently high at 3.7% and the economy is relatively good, it is expected that if the inflation trend breaks and the economic downturn becomes visible, the monetary policy stance of the U.S. Federal Reserve (Fed) will change, which could have a significant impact on the South Korean economy.
The once-hot U.S. economy…’ fiscal spending and consumption’ impact
The U.S. economy has shown a uniquely strong performance even as the economies of major countries have been slowing since last year. On an annual basis, the U.S. economic growth rate contracted by -0.6% in the first quarter of last year, followed by four consecutive quarters of growth in the 2% range and expanded significantly to 4.9% in the third quarter of this year. This is the highest growth rate since the 7.0% growth in the fourth quarter of 2021 due to the base effect of COVID-19, much higher than market expectations. Considering that the growth rate of South Korea, which has a smaller economy than the U.S., was 1.4%, 0.9%, 0.9%, and 1.4%, respectively, from the fourth quarter of last year to the third quarter of this year on a year-on-year basis, there is a lot of analysis that the U.S. growth is exceptional.
Many opinions have emerged that the U.S. economy will continue to grow next year without a hard landing. The Organization for Economic Cooperation and Development (OECD) has raised its potential growth rate for the U.S. next year to 1.9%, up 0.1 percentage point from the previous forecast, which is high compared to South Korea (1.7%), the UK (1.2%), Japan (0.2%), Italy (0.8%), and Germany (0.8%) among other major countries. This means that the U.S. economy is robust. Adam Posen, director of the Peterson Institute for International Economics, said earlier this month in an interview with Asia Economy, “I don’t agree that the U.S. economy will slump,” and “A year from now, the U.S. economy will show a rather robust growth.”
The U.S. economy is doing so well despite high interest rates, mainly due to massive fiscal spending and robust employment and consumption. The U.S. government has poured in an enormous amount of fiscal spending, increasing the fiscal deficit for the 2023 fiscal year to $1.695 trillion, which has maintained the vitality of the overall economy. In the U.S., more than 90% of mortgages are fixed-rate, so the impact on private consumption was insignificant despite the Fed’s steep interest rate hike, which also helped the U.S. economy continue its boom.
Deepening U.S. fiscal deficit…”The government will struggle to spend more”
However, recent major foreign media and experts say these factors supporting the U.S. economy are beginning to shake.
The concern about the U.S.’s excessive fiscal deficit is representative. Moody’s, an international credit rating agency, maintained the U.S. national credit rating at the highest ‘Aaa’ on the 10th (local time) but lowered its rating outlook from ‘stable’ to ‘negative.’ This implies that even the U.S. will struggle to handle such a fiscal deficit in a high interest-rate environment. The fiscal soundness of the U.S. is an issue repeated yearly. Still, Larry Summers, a former U.S. Treasury Secretary and professor at Harvard University, recently said, “The U.S.’s fiscal situation could be more serious than we think,” which has increased anxiety.
Lee Woong-chan, a researcher at Hi Investment & Securities, said, “In this interest rate environment, it is difficult for both consumers and the U.S. government to spend money,” and explained, “The fiscal expansion policy, non-residential investment, and consumption have led the U.S. economy to be strong, but as long as we have experienced a sharp rise in long-term interest rates, it seems difficult to expand fiscal policy next year.”
There is a point that the U.S., which holds the key currency, the dollar, continuing to make massive fiscal spending could be a problem. The Financial Research Institute predicted in a report on the 12th that if the U.S.’s budgetary deficit expands and the risk of a national credit rating increases, causing long-term interest rates to rise, the investment environment in real assets will deteriorate, leading to an economic downturn. The U.S. 10-year Treasury yield has been increased to the highest level in 16 years at 4.6%, and if this trend continues, not only will the federal government’s interest expenses increase, but the vitality of the overall employment, financial, and housing markets could also fade, according to the analysis.
U.S. youth delinquency rate surges…Is consumption also shaking?
There is also a growing concern about U.S. consumption. While South Korea is heavily impacted by interest rate hikes due to the high proportion of variable rates in housing mortgages, the U.S. has a limited impact on consumption due to the overwhelming majority of fixed rates. However, recently, the U.S. has seen a rise in delinquency rates centered around credit cards. The Federal Reserve Bank of New York explained in a report last week, “While the delinquency rate of mortgages, which account for the largest share of household debt, is lower than pre-pandemic levels, the delinquency rates of auto loans and credit cards have exceeded pre-pandemic levels and continue to rise.”
According to the report, the delinquency rate has notably increased among millennials (born 1980-1994), who comprise a large share of the U.S. consumer market. Ryu Jin-yi, a researcher at Hi Investment & Securities, said, “We believe that the debt burden has rapidly expanded as people in their 20s and 30s purchased cars amid soaring car prices during the pandemic, and the repayment of student loans also resumed,” and added, “Next year, the U.S.’s fiscal policy can only be reduced compared to this year, and political uncertainty is expected to limit corporate investment sentiment further, so consumption and investment, which were the two pillars of growth this year, seem to face difficulties at the same time.”
Indeed, if U.S. inflation breaks and the economy slows, it is expected to impact South Korean exports and monetary policy significantly.
Firstly, it could be damaging in terms of exports. This year, amid a slowdown in China’s economy and the semiconductor market, exports to the U.S., mainly related to automobiles, have surged, supporting growth. If the U.S. boom slows, some export items could be hit. On the other hand, constraints are expected to ease in terms of monetary policy. If the inflation rate converges to the target level (2% annually) and the Fed returns to monetary easing, the Bank of Korea could also see reduced tightening pressure.
Between a soft landing and a hard landing…Fed’s hawkish stance to continue for the time being
Of course, it cannot be ruled out that U.S. prices and the economy will not break for a considerable period. Many forecasts suggest that the U.S. consumer price index (CPI) inflation rate for October, which will be announced this afternoon Korean time, will slow down. Still, the core CPI, excluding food and energy, is likely to maintain a 4% year-on-year increase. Although there are significant concerns about consumption and fiscal deficits, the Biden administration’s reshoring (return of overseas companies) policy could support growth if it takes effect. U.S. Treasury Secretary Janet Yellen has also recently drawn a line on the possibility of an economic downturn.
The Fed is expected to maintain a hawkish stance for now, focusing on price stability between a soft and hard landing. The International Finance Center predicted in a report on the 13th, “Inflation easing is continuing, but it is still high compared to the target,” and “As a result, many Fed officials are expected to express their willingness to suppress inflation by keeping the possibility of a rate hike open, despite signs of inflation easing.” Jeon Kyu-Yeon, a researcher at Hana Securities, explained, “Weak tightening can induce inflation entrenchment and additional interest rate hikes, and excessive tightening can cause credit crunch, both of which pose risks of leading to a soft landing. The Fed will likely be cautious in adjusting interest rates next year.”
By. Moon Won
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