America’s Turbo Economy

Summary

• Business spending generates household income and spending and, in turn, more business spending.
• A very low savings rate on the household side and the Biden administration’s industrial policies on the business side have turbocharged this positive feedback loop.
• So far, the turbo economy has not caused overheating, largely due to high profits and a weak residential investment recovery.
• However, I am monitoring this risk closely because overheating would likely end disinflation.

Market Implications

• I still expect the first Federal Reserve (Fed) cut in June, in line with market expectations.

Hot Growth

Growth is not slowing. The Atlanta Fed Q1 nowcast has just been revised up to 3.2%, the same as Q4 GDP growth. This is despite a 525bp increase in the Federal Funds Rate (FFR) over 16 months, not to mention $1.4tn in quantitative tightening.

This note discusses possible reasons and implications for the Fed’s, and my own, policy views.

The ongoing growth acceleration largely reflects a positive feedback loop between the household and business sectors. Businesses spending generates income for the household sector. Household income in turn generates demand for the business sector: consumption accounts for 70% of US GDP.

A rock-bottom household savings rate and the Biden administration’s industrial policies have turbocharged this feedback loop over the past year.

Low Savings Turbocharge Consumption

The post-pandemic recovery in consumption has been exceptional. After the 2020 recession, consumption took only a year to return to the pre-pandemic trend (Chart 1). By contrast, it took eight years after the GFC.

Consumption strength reflects two broad factors. First, the strong labour market and pickup in real labour income growth. Labour income (wages times employment) is the biggest and most important driver of disposable income (Chart 2).

Because of the exceptional policy response, and because the pandemic was more of a mass furlough than recession, employment growth was exceptionally strong in the early stages of the recovery. Also, real wage growth was initially negative largely due to lags in the transmission of low unemployment to wages. Eventually, real wage growth turned positive, further lifting real income growth.

The second factor driving fast consumption growth is the low savings rate, which remains much lower than before the pandemic. The decline in the savings rate is associated with higher consumption of goods, mainly cars, recreational goods, and food, with the latter reflecting more higher prices than quantities. By contrast, services consumption is unchanged from pre-pandemic levels (Chart 3). Goods consumption is returning to pre-pandemic trends, but slowly, suggesting the savings rate could remain low for a while.

Strong household balance sheets enable the low savings rate (Chart 4). Even after the recent financial market volatility, net worth remains at pre-pandemic levels. Total debt has fallen relative to income, and the debt service ratio is roughly the same as before the pandemic. This shows the limited impact of Fed tightening.

The household savings rate is the lowest since before the GFC (Chart 5). It became unsustainable in the mid-2000s.

This time, though, there are no obvious financial imbalances, and the low savings rate could be sustainable. A lower savings rate implies that a greater share of the labour income generated by the business sector is recycled as demand for businesses goods and services.

Also, on the business side, the Biden administration’s industrial policy is fuelling business spending.

Industrial Policy Supercharging Business Spending

Since inauguration, the Biden administration has implemented several programs subsidizing private domestic industry. These include the American Rescue Plan (2021), Infrastructure Investment and Jobs Act (2021), the Inflation Reduction Act (2022), and the Chips and Science Act (2023). They provide subsidies to transportation infrastructure, EVs, high speed internet, semiconductor manufacturers, and clean energy producers, representing more than $600bn.

These subsidies have proven a potent form of public spending. Manufacturing construction has doubled in real terms since 2021, and construction employment is 10% above pre-pandemic levels (Chart 6).

Additionally, the full impact of the subsidies on manufacturing employment and equipment has yet to be felt. Manufacturing employment has been flat since 2022. There has been much less of a recovery in equipment than in structures (i.e., non-residential construction, Chart 7). But eventually the facilities being built must be filled with equipment and workers  hired. This will boost business spending and household income.

Market Consequences

Is the turbo economy consistent with continued disinflation? An improving current account balance suggests it is, so far. Large profits and a subdued residential investment recovery are translating into a large private sector excess of savings over investment. This is offsetting public sector dis-savings (Chart 8). As a result, the economy is not overheating.

However, the risk is that the investment recovery could broaden beyond manufacturing investment. This would require households or business savings (= profits) increasing in sync. Otherwise, the economy could experience resource pressures that could interrupt disinflation.

This is not my base case, but I am monitoring this risk closely. Lower household savings or corporate profits and faster investment would make me reconsider.

For now, I still expect disinflation to remain on track and the Fed to start cutting in June.

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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)