The odds of a US recession in the next 12 months have receded in light of the continued willingness of US households to spend more — despite far higher interest rates and reductions in the supply of money and bank credit.
US spending on goods and food services rose 0.7% in September on top of a robust increase of 0.8% in August. The annual increase in retail sales is 3.7%, and the increase over the past three months is running at an annual equivalent of 8%.
Prices at retail level are falling. This stimulates demand but also devalues the inventories that need to be held to satisfy demand. Prices have their supply and demand causes. They also have their effects on demand — and supply. Lower prices stimulate demand, and incomes are now growing faster than prices.
All that is holding up the US consumer price index (CPI) — now 3.7% higher than a year ago — are house prices and what is imputed as owner’s equivalent rent. That is what the owners could earn if they rented their homes out. This is up 7% on a year before and it has a huge weight in the CPI — more than 25%. If excluded from the CPI, headline inflation in the US would be running below the 2% target.
Cash rentals account for a further 7% of the US CPI. By contrast, food eaten at home carries a weight of only 8.6% in the CPI and food eaten out is at 4.8%.
SA also includes owners’ equivalent rent in its CPI with a weight of 12.99%, and actual rentals account for only 3.5% of the index. Both rental series in SA are up a below-average 2.6% on a year before. The headline inflation rate was 5.4% in September.
Owner’s equivalent rent is a different animal to other prices. Higher implicit rentals based on the improved value of an owner’s home are not the usual drag on spending. The extra wealth in homes will encourage more spending, not less, as would all increases in household wealth, more valuable pension plans and more valuable share portfolios.
The boom in US house prices post-Covid-19 has had much to do with the ability and willingness of US households to spend more and help push up prices generally. Average house prices in the US are now falling, though, under pressure from higher mortgage rates. House price inflation is falling away rapidly, as is owner’s equivalent rentals. This is helping to reduce headline inflation.
The question investors are asking about both inflation (falling) and the state of the economy (holding up) is what it will mean for interest rates. The stronger the economy the less the pressure on the US Federal Reserve to lower short rates, and the greater the pressure on long-term rates in the US.
The key 10-year Treasury bond is now offering 4.9% a year, a 16-year high. In the share market, what is expected to be gained on the swings of earnings may be lost on the roundabouts of higher interest rates, used to discount future earnings. But if inflation is subdued, any visible weakness in the economy can be followed immediately by lower interest rates. This thought will be consoling to investors.
The attention paid to GDP by investors is fully justified. Where GDP goes, so will the earnings reported by companies. Helpful for shareholders in recent years is that earnings have been running well ahead of costs, indicating widening profit margins from the IT giants.
On a quarter-to-quarter basis GDP is a highly volatile series, but growth in earnings is even more volatile.
The underlying trend in GDP and earnings will never be obvious. To make sense of their momentum, to recognise some persistent cycle, the data must be smoothed and compared to a year before. Thus, we will know only in a year or more whether the US economy has escaped a recession. It is not recessions that move markets, only expected recessions do so. And the jury will always remain out.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
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