All Eyes On The Fed… But Will It Change The US Forecast?

Federal Reserve Policies At The Root Of Recent Bank Collapses; California: A Better Recovery Than We Thought!

The recession forecasted by so many still hasn’t shown up and is looking less and less likely to anytime soon, according to Beacon Economics‘ latest outlook for the United States and California. Moreover, the recent bank failures that have been capturing headlines are being ‘wrongly viewed’ as heralding a coming downturn, something that misses the actual drivers behind the collapses and that key economic data refutes.

“These bank failures are not a reflection of an unhealthy U.S. economy, they are all about Federal Reserve policy,” said Christopher Thornberg, Founding Partner of Beacon Economics and one of the forecast authors. “Sad by true; the body that is supposed to be the wise shepherd of the nation’s banking system is largely responsible for creating the very stressors that caused Silicon Valley Bank to fail, and the run on others to begin.”

According to the outlook, the U.S. banking system, overall, is the victim of quixotic and rapid changes in Fed policy over the last three years as they have tried to maintain both full employment and price stability – which can be mutually exclusive. “In their existential panic over full employment during the pandemic, the Fed destabilized prices by injecting historic amounts of cash into the economy; in their existential panic over price instability, they destabilized the banking system through interest rate increases,” said Thornberg.

The new outlook acknowledges that the sudden crosscurrents from the bank failures have made the forecast fuzzier because stress in the banking system will eventually show up in the broader economy in the form of tightening credit. However, the new forecast does not believe those stressors, on their own, will rise to the level of a recession. “Cash is still king in the U.S. economy,” said Thornberg. “But if the Fed decides to continue raising interest rates in its quest to slow inflation, it will do more damage to the bank credit industry and that will trigger negative consequences for the overall economy.”

Assuming the Fed slows their roll, which they’ve shown some signs of doing, Beacon Economics is expecting slow growth and no recession in the near-term future. The forecast has real U.S. GDP growth in the first quarter coming in between 1% and 2%, although the margin of error has increased given the policy uncertainty.

In terms of the macro economy, the new outlook points to copious evidence of its health: unemployment in the nation remains rock bottom, consumer spending continues despite inflation, earnings growth is still running above 6% for the median worker, U.S. household net worth remains 30% ($30 trillion) higher than it was pre-pandemic, banks are not experiencing an increase in problem loans, and interest rates have started to stabilize causing asset markets to do the same.

In California, the news grew rosier this month after the state released its annual employment revisions, although a declining workforce continues to hamper economic growth. The revision shows that California recovered more and faster from the pandemic’s job losses than previously estimated: There are 197,000 more people employed in the state today than there were pre-pandemic. The original estimates had the gain at a mere 70,000.

However, in terms of the percentage increase, California’s job growth has been about five times slower than states such as Florida and Texas. “The underperformance we’ve seen is certainly not due to any unwillingness on the part of the state’s employers to hire workers,” said Taner Osman, Research Manager at Beacon Economics and one of the forecast authors. “Rather, California’s labor force contracted during the pandemic and there are well over 300,000 fewer workers in the state today than there were before COVID hit; there are simply not enough workers to fill the number of job openings.”

Deeply linked to its declining workforce is California’s famously expensive housing market, where prices surged an astounding 41% during the early days of the pandemic. Today, higher interest rates have led to a collapse in demand and home sales have returned to their pre-pandemic trough. However, home prices remain 27% above where they were pre-pandemic and the new forecast only expects them to fall by 6.3% in 2023. “Given California’s acute long-term housing shortage, it’s not surprising that price drops will be limited,” said Osman. “And this isn’t anything like the Great Recession because consumer balance sheets are so much stronger today and unemployment rates are at all-time lows.”