By many measures the U.S. economy is in good shape in the fall of 2022.
The labor market is excellent, with strong job growth and the unemployment rate close to the lowest it is has been in 50 years. Consumers continue to spend despite high inflation. And after surging in early 2022, gasoline prices have dropped sharply in the past few months, down by about $1 per gallon in the Pittsburgh area since June.
But there are big concerns.
Although inflation has slowed somewhat in recent months, it is still running near the fastest pace in 40 years. In response, the Federal Reserve has raised interest rates sharply in an effort to cool off growth and slow inflation; the central bank increased the fed funds rate — its key short-term interest rate — by another three-quarters of a percentage point on Sept. 21. The fed funds rate, which was close to 0% at the beginning of 2022, is now above 3%, and set to rise higher into 2023.
The drag from higher interest rates is starting to show up in the economy, most noticeably in the housing market.
With the typical interest rate on a 30-year mortgage now above 6% for the first time since 2008, up from around 3% in late 2021, housing activity is quickly slowing. Single-family housing starts have fallen in five of the past six months, down by almost one-quarter. Sales of existing single-family homes have dropped for seven straight months and are also down by one-quarter.
This is what the Fed is trying to do — cool off growth, especially in interest rate-sensitive industries like housing — in an effort to push inflation back down to the central bank’s 2% objective. But although the economy is growing right now, the risk is that the Fed could overdo it and push the economy into recession.
The Fall 2022 results from PNC’s semiannual Economic Outlook survey of small and mid-sized businesses reflect this dichotomy in the U.S. economy— Conditions are solid now, but the potential for a near-term recession is high.
Nearly one-half (49%) of the executives at small and mid-sized businesses surveyed were optimistic about their own company’s prospects over the next six months, with another 44% moderately optimistic. Only 7% were pessimistic, although this was up from just 2% in the Spring 2022 survey, before the Russian invasion of Ukraine and a surge in inflation.
And respondents were also upbeat about the U.S. economy, with 76% either optimistic or moderately optimistic about prospects for the next six months. Results were even better regarding respondents’ local economies, with 88% either optimistic or moderately optimistic.
But even though these executives are feeling quite positive about current conditions, they are very nervous about the near-term path of the U.S. economy.
More than two-thirds (69%) think a recession is likely in the next year, with 30% thinking it is very likely. Several concerns are weighing on these businesspeople: higher input costs, labor shortages and rising compensation costs, and continuing problems with supply chains, along with higher interest rates. They are responding to these problems by raising prices, changing the ways they pay workers (retention and hiring bonuses, etc.), and reconfiguring their supply chains, but these challenges will persist into next year.
Given all these problems, it’s not terribly surprising that more than two-thirds of executives at small and mid-sized businesses think that a recession is likely over the next year.
PNC’s baseline forecast is for much weaker economic growth in 2023 as the U.S. economy absorbs the full impact of the big increase in interest rates that started early this year.
The most likely outcome is that the U.S. economy manages to avoid a recession over the next couple of years, given that the job market remains very strong, consumer spending is generally holding up despite high inflation and there are early indications that inflation peaked in mid-2022.
But recession risks are elevated: PNC puts the probability of recession over the next couple of years at around 45%; this is about double the probability prior to the Russian invasion of Ukraine.
The results from the Fall 2022 survey of small and mid-sized businesses are consistent with PNC’s baseline expectations for weaker growth, but no recession, over the next couple of years.
However, conditions continue to change rapidly, and there are many potential causes of recession out there: higher interest rates, another surge in energy prices, a recession in Europe because of reduced natural gas supplies, much weaker growth in China or some combination of these factors.
But there are also potential positive developments, such as quick end to the war in Ukraine. Much will depend on how the Federal Reserve responds to quickly changing economic conditions, but for now, the most likely outcome is some bumps along the way but no U.S. recession.
Gus Faucher is senior vice president and chief economist of The PNC Financial Services Group. He shares his insights on the regional economy each month.
First Published: September 26, 2022, 4:51 p.m.