The "Fog" of the U.S. Economy

Main Content

Resident consumption drives the US Q2 GDP beyond market expectations, alleviating concerns about a recession in the US economy. Although the US economy is assumed to have a soft landing for the whole year, the economic trend is still cooling down. The focus is on the risks of stagflation after Trump's re-election and rate cuts.

The "Fog" of the US Economy - Outlook Based on Q2 GDP

(1) Why did the US Q2 GDP exceed market expectations? Resident consumption as the main driver, with inventory replenishment, equipment investment, and government investment as supplements

The actual annualized quarter-on-quarter GDP growth rate for Q2 2024 in the US was 2.8%, far exceeding the market's expectation of 2.0%. The strong quarter-on-quarter GDP growth in the second quarter mainly came from resident consumption, followed by non-residential investment, government investment, and inventory replenishment supporting the economy. The wealth effect may partially explain the strength in consumer goods consumption by residents. Market expectations for a rate cut by the Federal Reserve in the US increased significantly in the second quarter, leading to stock market gains and a shift towards looser financial conditions according to the Federal Reserve's financial conditions index.

Inventory replenishment and non-residential investment accelerated, while residential investment was impacted by high interest rates. Private inventories in the US increased by $71.3 billion in Q2 2024, mainly driven by the wholesale and retail industries, indicating the resilience of US consumer goods consumption. Inventory replenishment combined with previous construction investment led to a 5.2% annualized quarter-on-quarter growth in non-residential investment in Q2 2024, marking the third consecutive quarter of growth. Real estate investment cooled down quarter-on-quarter, mainly reflecting the impact of previous high interest rates. Domestic demand recovery led to an expansion of the trade deficit, with government spending providing support to the economy.

(2) How to look at the US economy in the second half of the year? Q2 was the peak, and the economy may cool down

The market expects the US economy to grow by 2.3% for the full year 2024, with the second quarter being the peak for the year and a slowdown in economic domestic demand expected in the third and fourth quarters. Looking at the structure, trends for resident consumption are downward, with a focus on the labor market and market interest rates. As the US job market cools down, wage growth slows, and tax payments weigh on income, US resident income in 2024 may continue to drag down consumer spending, further exacerbated by deteriorating consumer credit and savings depletion, leading to potentially greater cyclical pressure on overall US consumer spending in the future.

Private investment: Q2 may be the peak for the year, with a focus on capital expenditures and credit conditions going forward. With the transmission of high interest rates and weakening consumer goods consumption by residents, private investment in the US in the second half of the year may also face pressure. Among the three major private investments in the US, equipment investment may be the most resilient, as it is more likely to be driven by the lagged effects of the previous construction investment boom.

Government consumption and investment: Fiscal spending intensity may support the economy. Looking ahead to the second half of the year, in April, the Biden administration passed a foreign aid bill; in July, student loan forgiveness began to be implemented, and the scale of fiscal spending may further expand. The annual growth rate of fiscal spending may exceed last year's level, and the rising growth rate of fiscal spending may help support GDP growth.

We believe that recent financial market volatility may have a certain impact on US resident consumption in the second half of the year, and factors such as weakening job market conditions will further exacerbate this. This will further affect the pace of inventory replenishment, corporate expectations, while residential investment will also begin to reflect the impact of the surge in US bond rates in the first half of the year. The US economy in the second half of the year may continue to cool down, rather than further strengthening based on the second quarter Focus on the stagflation risks after Trump's re-election and the Fed rate cut

The market's expectation of a 50 basis point rate cut by the Fed in September has decreased, leading to a convergence in the expectations of a short-term economic recession. However, the market still holds strong expectations for a rate cut in September. In the fourth quarter, attention should be paid to the possibility of a combination of a slowdown in the U.S. economy and resistance to downward inflation. Looking ahead, in the fourth quarter, it is necessary to focus more on the slowdown of the U.S. economy, while also considering the market dynamics formed by the enhanced stickiness of CPI inflation (core non-durable goods inflation + rebound in rent + Fed rate cuts). Additionally, the risks of the U.S. presidential election in the second half of the year will also impact market expectations.

Risk Warning

Escalation of geopolitical conflicts; Fed turning "hawkish" again; accelerated financial conditions tightening.

The "Fog" of the U.S. Economy - Outlook Based on Q2 GDP

Why did the U.S. Q2 GDP exceed market expectations? Consumer spending as the main driver, supported by inventory replenishment, equipment investment, and government investment

On July 25th local time, the U.S. BEA announced the real GDP data for Q2 2024, with an annualized quarter-on-quarter growth rate of 2.8%, exceeding the market's expectation of 2.0%, and a year-on-year growth rate of 3.1%, far surpassing market expectations. Structurally, the strong performance of Q2 GDP quarter-on-quarter mainly came from consumer spending, followed by non-residential investment, government investment, and inventory replenishment supporting the economy. After the data was released, U.S. bond yields and the U.S. dollar index rose, indicating increased market confidence in the U.S. economy. Looking at the data, consumer spending, non-residential investment, and government investment increased quarter-on-quarter from 1.5%, 4.4%, 1.8% in the first quarter to 2.3%, 5.2%, 3.1% (annualized quarter-on-quarter) in Q2. Private inventories in Q2 increased by $71.3 billion, compared to an increase of only $28.6 billion in the previous quarter.

Strong consumer spending in Q2 2024 in the U.S. was mainly driven by a significant rebound in the annualized quarter-on-quarter growth rate of goods consumption from -2.3% in Q1 to 2.5% in Q2. However, the overall real consumer spending in Q2 (2.3%) was still weaker than the 2023 average of 2.8%, meaning that consumer spending in the second quarter was indeed stronger than in the first quarter, but still below last year's level.

1) Why did U.S. consumer goods consumption rebound in Q2? Starting from income and interest rates, U.S. residents' disposable income did not experience a significant rebound in the second quarter, so it may not have been income driving consumption. Therefore, from an interest rate perspective, the market's expectations of a Fed rate cut in the second quarter increased significantly, with stock market gains and a more accommodative Fed financial conditions index, likely being the main factors leading to the rebound in consumer goods consumption 2) In the second quarter, the annualized month-on-month growth rate of US residents' service consumption slowed to 2.2% from 3.3% in the first quarter, reflecting a cooling job market in the United States. This has been reflected in previous US employment data, with the unemployment rate rising and job vacancies falling.

In Q2 24, US private inventories increased by $71.3 billion, mainly driven by the wholesale and retail industries, corresponding to the resilience of US commodity consumption. In the face of more pressure on household employment and consumption in the future, the restocking efforts in this round cannot be compared with the previous round.

Restocking boost + transmission of previous construction investment, non-residential investment further heats up. In Q2 24, non-residential investment grew by 5.2% on an annualized month-on-month basis, continuing to rise for the third consecutive quarter. On the one hand, the United States entered a restocking cycle this year, and on the other hand, manufacturing construction investment stimulated by the previous Biden policies is gradually transforming into equipment investment.

Real estate investment cooled on a month-on-month basis, mainly reflecting the high interest rates in the previous period. The spike in US bond yields in the first quarter of this year led to a month-on-month decline of only -1.4% in actual residential investment in the second quarter (compared to 16% in the first quarter). Looking at its lagging relationship with the growth rate of new home sales, real estate investment may further cool down in the next 1-2 quarters, and the recent decline in US bond yields may not stimulate real estate investment transmission until at least the end of this year.

In Q2 24, the US net export deficit expanded, mainly reflecting a rebound in household consumption in the second quarter. The actual net export deficit in Q2 24 was $1.0 trillion, an increase of $46.7 billion from Q1, dragging down real GDP. This mainly reflects the strong domestic demand of US residents in the second quarter, completely overshadowing the export pull from the recovery of equipment investment and industrial production improvement in the United States.

As factors constraining fiscal expenditure recede, government investment supported the US economy in the second quarter. With the US FY24 fiscal appropriations passed on March 23, the factors that previously constrained fiscal expenditure such as government shutdowns and temporary appropriations restrictions have receded. It is evident in the second quarter that the intensity of US government spending has increased, with government consumption and investment in Q2 24 rising from 1.8% in the first quarter to 3.1%.

(2) How to look at the U.S. economy in the second half of the year? The second quarter is already at a peak, and the economy may cool down

Market expectations for the full-year 2024 U.S. economic growth rate are still expected to reach 2.3%, with the second quarter being the peak of the year, and economic domestic demand slowing down in the third and fourth quarters. How does the market view the U.S. economy in the second half of the year? According to Bloomberg's consensus expectations, the market expects the actual GDP growth rate in the United States in 2024 to be 2.3%, slightly lower than last year's 2.5%. Looking at the quarterly distribution, the market expects the growth rates for Q3 and Q4 of 2024 to be 1.5% each (annualized quarter-on-quarter), meaning that the actual GDP growth rate in the United States in the second quarter is the peak of the year. In terms of GDP structure, the market predicts that in the second half of the year, household consumption, government investment, private investment, and imports will all be weaker than in Q2 2024, while U.S. export growth may increase further in Q4 2024.

The trend of U.S. household consumption in the second half of the year is still cooling down, and future attention should be paid to developments in the labor market and changes in market interest rates. We believe that as the U.S. job market cools down, wage growth slows, and tax payments weigh on income, U.S. household income in 2024 may continue to drag down household consumption, further compounded by factors such as deteriorating consumer credit and consumption depletion. The cyclical pressure faced by overall U.S. household consumption in the future may be greater. From the logic of determining consumption, 1) on the one hand, it is necessary to track the degree of slackening in the labor market, such as job vacancies, wage growth and other indicators, which affect consumption through residents' income expectations; 2) on the other hand, as durable goods consumption in the United States highlights the sensitivity to "interest rates," this was already reflected in the second quarter data, and if the Fed starts cutting rates in September, it may partially boost consumption.

The month-on-month increase in U.S. imports in the second quarter was driven by a rebound in household goods consumption. If the growth rate of U.S. household consumption slows down in the future, the import growth rate will follow the same trend, as also reflected in market forecasts.

With the transmission of high interest rates in the previous period and the weakening of household goods consumption, private investment in the United States may also face pressure in the second half of the year. This scenario will also have an impact on U.S. exports, but it is also driven by overseas demand. Looking at the three major aspects of private investment, it is clear that in the second quarter, non-residential investment and inventory replenishment were stronger than residential investment. Looking ahead, residential investment may continue to weaken in the next 1-2 quarters under the influence of high interest rates in the previous period, and if U.S. household consumption weakens in the future, inventory replenishment may slow down, and equipment investment will also be partially affected Combining the three major private investments in the United States, the most resilient may be equipment investment, as it is more likely to be driven by the lagging effect of the previous construction investment boom. From a tracking perspective, sustainable indicators to focus on include corporate capital expenditure willingness and the credit conditions faced by enterprises to assess the investment prospects of the U.S. corporate sector.

The U.S. fiscal situation may still have support in the second half of the year. In June, the Congressional Budget Office (CBO) raised its forecast for the U.S. deficit in fiscal year 2024, expecting the U.S. deficit ratio to reach 7% in fiscal year 2024, an increase of 1.4 percentage points from the February forecast. Breaking down the revenue and expenditure items, the main reasons for the increase in the U.S. deficit this year are the Biden administration's expansion of Medicaid coverage, introduction of student loan forgiveness plans, and increased foreign aid expenditures in the election year. Looking ahead to the second half of the year, in April, the Biden administration's foreign aid bill was passed; in July, student loan forgiveness began to be implemented, and the scale of fiscal expenditures may further expand. The full-year growth rate of fiscal expenditures may exceed last year's level, and the increase in fiscal expenditure growth rate may help support GDP growth.

(3) Focus on the stagflation risks after Trump's return to office and the Fed's rate cut

The baseline expectation for the U.S. economy in 2024 is still a soft landing, but the U.S. economy may cool down in the second half of the year. The factors that led to the U.S. economy outperforming market expectations in the second quarter mainly came from domestic consumer demand, which was more driven by the wealth effect of the previous stock market rally. This also means that recent market volatility may have a certain impact on U.S. consumer spending in the second half of the year, and factors such as weakening job market conditions will further exacerbate this. This will further affect the pace of restocking, corporate expectations, and residential investment will also begin to reflect the impact of the surge in U.S. bond yields in the first half of the year. In summary, the U.S. economy may still cool down in the second half of the year, rather than further strengthening based on the second quarter, but factors such as fiscal support lead us to believe that the baseline assumption for the U.S. economy for the whole year is still a soft landing, but the economic trend may indeed cool down in the second half of the year.

Market expectations for a 50 basis point rate cut by the Fed in September have decreased, and expectations of a short-term economic recession have moderated. Since 2024, market expectations for the U.S. economy and the Fed's rate cut have shown "pendulum-like" fluctuations. In the first quarter, driven by stronger-than-expected U.S. inflation and the impact of expectations that the U.S. economy would not land, the 10-year U.S. bond yield soared to 4.7%. However, a series of weaker economic data and inflation data in the second quarter led the market to revise its previous expectations, until it began to worry about the risk of the U.S. economy rapidly entering a recession The second-quarter GDP data in the United States to some extent dispelled some concerns. Based on this, the market has lowered its expectations for a 50 basis point rate cut in the September meeting, but the expectation for starting rate cuts in September remains strong (combination of falling inflation and the resilience of GDP soft landing).

In the fourth quarter, attention should be paid to the possibility of a combination of slowing U.S. economic growth and resistance to declining inflation. Looking ahead, in the fourth quarter, more attention should be paid to the slowing U.S. economy, but at the same time, the market situation formed by the enhanced stickiness of CPI inflation (core non-durable goods inflation + rebound in rent + Fed rate cuts). In addition, the risk of the U.S. presidential election in the second half of the year will also be reflected in the impact on financial market expectations.

Wang Maoyu (A0230521120001)