about 1 month ago • 2 mins
The continued strength of the US economy has left many (me included) scratching their heads. Weren’t those aggressive, inflation-busting interest rate hikes supposed to bring the economy to its knee?
Apollo’s chief economist, Torsten Slok, has been looking into the question and says, to unravel the mystery of the still-standing US economy, you need to take a deeper look into the mechanics of gross domestic product (GDP) – that is, the broadest measure of the goods and services it creates
Specifically, Slok advises splitting real GDP (that’s the same broad measure, but adjusted for inflation) into two parts: cyclical and non-cyclical components. Cyclical parts are the ones that are sensitive to interest rates: like spending on housing, long-term business investments (so-called capital expenditures), and bigger-ticket items like cars and appliances (durable goods). Non-cyclical components are the ones less affected by rates, include activities like dining out, hotel stays, and air travel.
Interestingly, non-cyclical sectors (dark blue line) have shown remarkable resilience. They’ve slowed for the past two years, but remained positive, helped by consumer demand and savings that were built up during lockdown periods, when things like travel and entertainment were restricted.
But even more interesting is what’s happened with cyclical things (green). When the Fed started raising rates, they slowed way down – especially housing – and that slowdown helped push core inflation lower, as expected. But then came a plot twist: troubles in the US banking system caused authorities to pump a lot of money into the economy, in effect, balancing out the impact of those rate hikes. This move stopped the drop in asset prices and kicked off a surge in stocks, credit, and Treasury markets. This made financial conditions easier again, and gave a boost to the cyclical sectors of the economy.
So the US economy’s robustness comes down to two drivers: pent-up buying demand from the lockdown era, and a major boost in money conditions, which effectively softened the blow from the rise in interest rates.
The takeaway here is good news and bad news. On the bright side, the rally in asset prices and the pause in interest rate hikes means liquidity is still pretty flush, and that reduces the risk of a recession over the short term. The darker side is that the same factors could lead to a rise in inflation again. And if that happens, the Fed might have to step back in and tighten up financial conditions again, which could put a dampener on the recent surge in asset prices. But for now, we’re in a sort of sweet spot of lower inflation and robust growth, so let’s hope for the best.
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