[Why&Next] The Hot US Economy, Is a Recession Coming... Shaking 'Fiscal Policy and Consumption'

Unexpected Boom in US... Increasing Recession Forecasts
Worsening Fiscal Deficit... Growing Concerns Over High Interest Rates
Rising Delinquency Rates Among US Youth, Negative Impact on Consumption
October Inflation in Focus... 'Hawkish Fed' Continues

Despite the global high interest rates, there is growing analysis that the U.S. economy, which had been experiencing a 'solo boom,' is entering a recession phase. This is because the massive fiscal spending and employment and consumption indicators that have supported the U.S. economy are gradually showing cracks. Although the U.S. inflation rate is still high at 3.7% and the economy is relatively stable, if the inflation trend slows and the recession becomes visible, the Federal Reserve's (Fed) monetary policy stance is expected to change, which will have a significant impact on the Korean economy.

The Hot U.S. Economy... Impact of 'Fiscal Spending and Consumption'

The U.S. economy has shown particularly strong performance even as major economies slowed down since last year. The U.S. economic growth rate, after contracting by -0.6% annualized in Q1 last year, continued to grow at around 2% for four consecutive quarters, then sharply expanded to 4.9% in Q3 this year. This is the highest growth rate since the 7.0% growth in Q4 2021 due to the COVID-19 base effect, and it far exceeds market expectations. Considering that South Korea, with a smaller economy than the U.S., recorded growth rates of 1.4%, 0.9%, 0.9%, and 1.4% from Q4 last year to Q3 this year on a year-on-year basis, many analyses regard the U.S. growth as exceptional.

Accordingly, many opinions suggest that the U.S. economy will continue to grow without a hard landing next year. The Organization for Economic Cooperation and Development (OECD) raised the U.S.'s potential growth rate for next year by 0.1 percentage points to 1.9%, which is higher than South Korea (1.7%), as well as major countries such as the UK (1.2%), Japan (0.2%), Italy (0.8%), and Germany (0.8%). This indicates the robustness of the U.S. economy. Adam Posen, president of the Peterson Institute for International Economics, said in an interview with Asia Economy earlier this month, "I do not agree that the U.S. economy will enter a recession," adding, "One year from now, the U.S. economy will show rather solid growth."

The strong performance of the U.S. economy despite high interest rates is mainly attributed to massive fiscal spending and solid employment and consumption. The U.S. government significantly increased the fiscal deficit to $1.695 trillion for the 2023 fiscal year, pouring enormous funds that maintained overall economic vitality. Since over 90% of U.S. mortgages are fixed-rate, the sharp rate hikes by the Fed have had limited impact on private consumption, which also helped sustain the U.S. economic boom.

Worsening U.S. Fiscal Deficit... "Government Will Find It Harder to Spend More"

However, according to recent major foreign media and experts, these factors supporting the U.S. economy are gradually weakening.

Concerns about the excessive U.S. fiscal deficit are representative. On the 10th (local time), Moody's Investors Service maintained the U.S. sovereign credit rating at the highest level of 'Aaa' but downgraded the outlook from 'stable' to 'negative.' This implies that even the U.S. may find it difficult to sustain the current fiscal deficit under high interest rates. Although U.S. fiscal soundness is a recurring issue every year, concerns have intensified recently, with former U.S. Treasury Secretary and Harvard professor Larry Summers stating, "The U.S. fiscal situation may be more serious than expected."

Lee Woong-chan, a researcher at Hi Investment & Securities, explained, "At these interest rates, it is difficult for both consumers and the U.S. government to spend money. Fiscal expansion policies, non-residential investment, and consumption have driven the U.S. economic strength, but after experiencing a sharp rise in long-term interest rates, fiscal expansion next year seems difficult."

There are also concerns that the U.S., holding the global reserve currency dollar, continuing massive fiscal spending could itself become problematic. The Korea Institute of Finance forecasted in a report on the 12th that if the U.S. fiscal deficit expands and the sovereign credit risk increases, leading to higher long-term interest rates, the investment environment for real assets could deteriorate, causing the economy to contract. The U.S. 10-year Treasury yield has risen to the mid-4.6% range, the highest in 16 years. If this trend continues, not only will the federal government's interest expenses increase, but the vitality of employment, finance, and the housing market could also decline.

U.S. Youth Delinquency Rates Surge... Is Consumption Also Shaking?

Concerns about U.S. consumption are also intensifying. In South Korea, variable-rate mortgages constitute a large portion, so consumption is heavily impacted during rate hikes, whereas in the U.S., fixed-rate mortgages dominate, limiting the impact on consumption. However, recently, delinquency rates, especially on credit cards, have been rising in the U.S. The New York Federal Reserve Bank explained in a report last week, "While mortgage delinquency rates, which account for the largest share of household debt, remain below pre-pandemic levels, delinquency rates on auto loans and credit cards have exceeded pre-pandemic levels and continue to rise."

According to the report, delinquency rates have notably increased among the millennial generation (born 1980?1994), which holds a significant share in the U.S. consumer market. Ryu Jin-yi, a researcher at Hi Investment & Securities, said, "People in their 20s and 30s purchased cars during the pandemic period when car prices surged, and with student loan repayments resuming, their debt burden has rapidly increased. Next year, U.S. fiscal policy will inevitably contract compared to this year, and political uncertainty is expected to further restrict corporate investment sentiment, so consumption and investment, which were the two pillars of this year's growth, will face challenges simultaneously."

In fact, if U.S. inflation slows and the economy weakens, it is expected to have a significant impact on Korean exports and monetary policy.

From an export perspective, the outlook could be negative. This year, despite sluggish Chinese economic conditions and semiconductor markets, growth was supported by a sharp increase in automobile-related exports to the U.S. If the U.S. boom subsides, exports of some items could be hit. On the other hand, from a monetary policy perspective, constraints are expected to ease. If inflation converges toward the target level (2% annually) and the Fed shifts to monetary easing, the Bank of Korea may also face reduced tightening pressure.

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), is speaking as a panelist at a conference hosted by the International Monetary Fund (IMF) in Washington DC on the 9th (local time).
[Photo by Yonhap News]

Between Hard Landing and Soft Landing... Fed's Hawkish Stance to Continue for Now

Of course, the possibility that U.S. inflation and the economy will not sharply decline for a considerable period cannot be ruled out. Although many expect the U.S. consumer price index (CPI) for October, to be released this afternoon Korean time, to slow down, the core CPI excluding food and energy is likely to maintain a 4% year-on-year increase. Despite concerns about consumption and fiscal deficits, the Biden administration's reshoring policy (bringing overseas companies back to the domestic market) is showing effects, providing room to sustain growth. U.S. Treasury Secretary Janet Yellen has also recently drawn a line on the possibility of a recession.

The Fed is expected to maintain a hawkish stance focusing on price stability for the time being, balancing between a hard landing and a soft landing. The International Finance Center stated in a report on the 13th, "Although inflation easing continues, it remains above the target level," adding, "As a result, many Fed officials are expected to express their determination to curb inflation by keeping the possibility of rate hikes open despite signs of easing inflation." Jeon Gyu-yeon, a researcher at Hana Securities, explained, "Weak tightening induces inflation persistence and additional rate hikes, while excessive tightening causes credit crunches, both of which risk leading to a hard landing. The Fed is expected to be cautious with rate adjustments next year as well."