The Beat Goes On: U.S. GDP growing at moderate pace, local unemployment rate up slightly

Source: U.S. Bureau of Economic Analysis. Gross Domestic Product (Advance estimate for most recent quarter).

Consumer spending has been the key to GDP growth in this cycle as consumers were largely unfazed by the rapid increase in interest rates from 2022 to 2023. As long as the consumer can fill in the gap left by decreasing investment spending, the expansion can continue. However, increasing corporate layoffs nationwide in recent months have put pressure on the consumer. Furthermore, consumer spending is likely being driven at least partially by a wealth effect from the rising stock market and housing valuations, neither of which can continue rising at this rate indefinitely.

In this way, the current cycle bears some resemblance to conditions in late 1999 and early 2000. Both then and now, residential investment spending decreased, putting a significant drag on overall investment. In 2000, consumer spending was able to prop up GDP for a few more months, but as the dot-com bubble burst, the wealth effect for consumers diminished. A recession soon followed.

One important difference between then and now is that the Fed was still raising rates until mid-2000 even as residential investment was starting to fall. At that time the fed funds rate was 6.5%, the highest since the 1980s and well above where we are now. The first rate cut in January 2001 was too late as by that time overall investment was now falling as well. It did not help matters that oil prices had risen from around $15/barrel in 1999 to over $25/barrel in 2000.

Turning attention back to the present day, while many would have liked to see the Fed cut rates sooner, they did begin cutting while investment growth is still positive. Additionally, oil prices have been relatively stable for the last two years, trading mostly in a range from $70 to $90/barrel. As of September, oil dipped below $70/barrel, testing post-COVID lows. This would suggest that a repeat of 2001 is not necessarily the most likely scenario.

Provided oil prices continue to trade in a narrow range and labor productivity continues to grow at a moderate pace, the current situation has more similarity to 1995 where the timing of the Fed’s first rate cut was a little better. Then as now, one of the first signs of weakness was residential investment. The Fed started cutting before the weakness spread. As a result, overall investment did not fall, and recession was avoided. This is the soft landing. With a little bit of good fortune in matters beyond our control (oil prices, geopolitics, productivity growth, etc.), we might be able to pull off a repeat of this rare event.

Sources: Bureau of Economic Analysis (Chart), U.S. Energy Information Administration (Oil price)

How does this analysis at the national level matter to us at the local and regional level? First and foremost, the most important determinant of economic growth at the regional level is growth at the national level. The U.S. economy is so interconnected that expansions and contractions are correlated across most regions of the country. Exceptions occur when there is some significant difference in the structure of the economy of a region that causes it to over- or under-perform the rest of the country in response to a specific economic event.

Because the Quad Cities region is heavily dependent on agriculture and manufacturing, it is more vulnerable to economic shocks that are specific to those industries. In recent months, agricultural commodity prices (especially corn and soybeans) have fluctuated more than usual, reaching decade-high levels before returning to pre-COVID prices.

Manufacturers nationwide have struggled with high financing costs and slowing demand. This has also impacted the Quad Cities region as manufacturing employment has remained flat for most of the year, as in the rest of the country.

The Federal Reserve "Beige Book" summary of economic conditions noted that the consumer spending in the Chicago district "increased modestly overall." However, they also noted that "customers across all income segments were 'trading down.'" That is, consumers were choosing less expensive substitutes for more expensive items. They also noted that business spending decreased slightly, and capital expenditures were down. Manufacturing demand was also down during the weeks preceding the November Fed meeting.

Both nationally and in the Chicago district, the Beige Book reports that while several areas of the economy have trended lower in recent weeks, their contacts remained optimistic.

Both Iowa and Illinois performed above the national average on the Weekly State-Level Economic Conditions Index during the third quarter, although both states as well as the U.S. as a whole are reading very close to zero on this index, which implies that they are all fairly close to their long-run averages.

This corresponds to the GDP numbers we noted at the beginning which are also very close to the long-run average. Note that the U.S. reading on this index is trending lower in recent weeks, which corroborates the emerging weakness in various areas, including the labor market, and suggests somewhat lower GDP in the future.

Source: Baumeister, C., Leiva-Leon, D., and Sims, E. (2021). Tracking Weekly State-Level Economic Conditions. Unpublished paper. Notre Dame University, Banco de Espana, National Bureau of Economic Research, and Center for Economic and Policy Research.

For the most part, the data acquired from different sources are in agreement. The labor market has slowed. Manufacturing, construction, and agricultural sectors are facing the stiffest headwinds. Yet consumer spending remains strong, even if there is starting to be evidence of "trading down" for less expensive options. We are seeing these features in the data at both the national and the local levels.

In that sense, there has not been much change over the last few months. GDP is still growing at a modest pace, near its long-run growth rate. The beat goes on.

Looking ahead, while there are certainly signs that point to further slowing. There are also plenty of positive signs. The Fed has begun cutting the policy interest rate, energy prices have fallen recently to give the consumer additional breathing room, and productivity continues to grow.

Our Business Outlook Survey also points to some positive signs. As we discuss in that section, there is a more positive sentiment from survey respondents about the next six months than about the quarter just ended.

There is now evidence to suggest that we are seeing the anticipated soft landing. Even so, we cannot declare victory until we see the economy turn the corner on some of these aforementioned areas of weakness. That will require continued productivity growth, additional Fed easing, stronger growth overseas, and geopolitical stability.

While a recession in the next year is still within the realm of possibility, if it were to happen it would probably be the result of some unforeseen event rather than something currently on the horizon.