November 10, 2023
The fourth quarter is underway and somehow the end of the year is in sight. While economic momentum remained robust in the third quarter, the markets, forward looking as they are, began pricing for a new set of risks as the fourth quarter approached. Softness continued in October with the S&P 500 stock index down about 2% and core bonds down roughly 1% amid rapidly rising interest rates. Despite the recent weakness, it is important to note that the S&P 500 is up 10% and core bonds are up 1% over the last year as 2023 continues to trend quite favorably compared to 2022.
Throughout most of 2023, the outlook for real US GDP growth has steadily improved. Economists’ forecasts for GDP growth rose solidly throughout the third quarter. As we head into the fourth quarter, a confluence of potential headwinds complicates the outlook.
Entering Q3, the median economist forecasted 0% growth for Q3 and a 0.5% decline for Q4. Today, we know that the economy actually expanded 4.9% in Q3 with 0.8% growth forecast in Q4 (all figures are presented as quarter-over-quarter seasonally adjusted annualized growth rates). Based on current projections, the first quarter of 2024 is now forecast to mark the near-term “low” point in the cycle with growth of 0.2%. Over the last several months, the economic “valley” has gotten shallower and pushed further into the future.
As the fourth quarter unfolds, we continue to monitor four converging risks that threaten continued growth. These risks include the implications of:
- Rising oil and gas prices
- A potential government shutdown
- Resumption of student loan repayments
- United Auto Workers’ strike
These concerns have the potential to hamper fourth quarter growth and the outlook for 2024 by a little, or a lot, depending on the extent of the combined fallout.
Rising oil and gas prices: Oil prices rose sharply during the third quarter from approximately $70 per barrel in June to a peak of nearly $94 per barrel in September. In October, prices remained volatile, but moderated to around $81 a barrel in spite of the outbreak of war in Israel. Of course rising oil prices correlate highly with higher prices at the pump which peaked around $4.00 per gallon (national average) before retreating to around $3.65 in October. Higher oil and gas prices threaten consumer spending in discretionary categories and contribute to inflation, particularly food inflation, as higher transportation costs are passed on to consumers.
Potential Government Shutdown: Just hours before a shutdown scheduled for October 1, House Republicans and Democrats struck a surprise deal to fund the government for another 45 days. While not a permanent solution, the deal allows the House and Senate to work on a more comprehensive funding plan. Unfortunately, the House was mostly inactive from October 3 through October 25 when the office of Speaker of the House stood vacant. Now that a new speaker has been elected, lawmakers must work toward a comprehensive funding plan against a fast-approaching November 17 deadline.
Resumption of Student Loan Repayments: The potential impact of resuming student loan repayments is perhaps the easiest risk to quantify. Average monthly student loan payments are estimated at $200-$350 per month per borrower, which equates to total additional collections of $5B-$6B per month, or $60B-$70B per year. If we assume that every dollar used to repay student loans would have otherwise been spent (not saved, not invested) then we might see a 0.4%-0.5% reduction in annual personal consumption expenditures. This reduction would have a direct impact on the 68% of the US economy driven by consumer spending. We should get a first glimpse into the drag created by student loan repayments with October retail sales figures due out in November.
United Auto Workers’ Strike: The United Auto Workers’ (UAW) strike against the Big Three automakers appears to be nearing resolution, which is good news considering the severity of its impact should depend on how protracted the demonstration becomes. Without resolution, impacts to the economy could potentially include reduced spending by striking workers who aren’t receiving paychecks as well as an inflationary effect on new and used vehicle prices.
Our analysis suggests that, collectively, these four events could negatively impact fourth quarter growth by anywhere from 0.25% to 1.5%. Current forecasts call for quarter over quarter deceleration of about 4.0%, but it is not clear how much of the anticipated slowdown is attributable to these or other factors. Fortunately, the labor market remains strong, the consumer remains on reasonably solid footing, and inflation is well off of peak levels.
US hiring unexpectedly surged in September by the most since January, highlighting continued resiliency of the labor market. The US economy added 336K jobs in September, nearly doubling expectations of +170K, accelerating from +227K in August (revised up from 187K originally reported) and +157K in July. US employment has grown by an average of 259K jobs per month in 2023, moderating from an average of 400K per month in 2022. Wage growth decelerated marginally with average hourly earnings up 4.2% over the last year (compared to 4.3% in August) and 0.2% month-over-month (in line with August and below expectations of +0.3%).
The most recent retail sales report from the month of September came in better than expected as well, underscoring the resiliency of consumer demand exiting the third quarter. Adjusted for inflation, retail spending increased 0.3% compared to August and 0.1% year-over-year. The advance showcases a gainfully employed American consumer that continues to spend money in spite of rising interest rates and stubborn inflation. Investors and economists will pay close attention to the October retail sales report, set to be released in November, looking for any indications that the restart of student loan payments is having a negative impact on consumer demand.
Turning to inflation, September data reported in October showed the Consumer Price Index (CPI) rose at 3.7% (year-over-year) for a second straight month. While the result is much improved from the June 2022 peak of 9.1%, it also marks a bump up from a recent low of 3.0% in June 2023. At +7.2% year-over-year, shelter costs decelerated slightly from +7.3% in August and a peak of 8.2% in March 2023. We continue to keep a close eye on shelter costs, which represent nearly one third of the CPI basket and tend to impact the index with a lag.
The crosscurrents affecting the US economy make the monetary policy-making environment exceptionally tenuous. In their efforts to facilitate a soft landing, Fed officials must continue to pursue a 2% inflation target, possibly keeping interest rates higher for an extended period, while considering external headwinds owing to higher oil prices, a potential government shutdown, student loan repayments and the UAW strike. On November 1, policymakers maintained the Federal Funds Rate target at 5.25%-5.50%, as expected. As it stands, the market is pricing in 25% odds of another hike in December with cuts priced in beginning with the May 2024 meeting.
We will continue to monitor headline events and economic health in the fourth quarter and look forward to sharing our perspective as the narrative evolves. As always, we encourage investors to lean on discipline and the benefit of a long time horizon during periods of uncertainty. On behalf of the entire team, thank you for allowing us to serve on your behalf.