Opinion: The US economy will likely enter a recession soon

Opinion by Dana Peterson and Erik Lundh

(CNN) — While US economic growth has defied expectations this year, clouds are gathering on the horizon. The all-important US consumers have stood their ground and continued to spend, and most data underlines spending strength. But some emerging information suggests that consumers may eventually stumble, which could drive the US into a brief recession.

To be clear, gross domestic product (GDP) growth has been surprisingly robust this year — and that’s largely due to strong consumer spending over the first half of 2023. First quarter GDP expanded by 2% and in the second quarter grew by 2.1%. At the end of last year, most economists expected the economy to contract over that period because of severe inflation and, in response, rapid interest rate increases. But rising wages, a war chest of pandemic savings and low debt levels have kept US consumers active this year despite these pressures.

So, what’s there to worry about?

Real personal income was flat in July, real disposable personal income (real personal income minus taxes) dropped in July for the first time in 13 months and the personal savings rate dropped in July. Meanwhile, consumer spending jumped in July, according to the Bureau of Economic Analysis. That all suggests that US consumers may be getting out over their skis with their buying habits.

To be sure, the tight labor market is still driving incomes up, but not as quickly as last year. And the Fed is intent on softening up the labor market to further curb inflation by targeting wages.

So, if spending growth is starting to exceed income growth, how are Americans paying for things? The answer is debt and savings, neither of which is sustainable.

During the second quarter, outstanding credit card debt rose to more than $1 trillion, and auto loans to nearly $1.6 trillion — both all-time highs. Granted, Americans are earning more, but the total household debt-to-annual personal income ratio is now back up to its pre-pandemic level, according to our calculations. Credit card delinquencies have also steadily climbed and are now back up to 2019 levels. Furthermore, interest rates on debt are higher than they’ve been in years, making monthly payments on rising balances even higher. Thus, further debt-fueled buying could be challenging for Americans. Most of us have run up credit cards at one point or another; paying them down usually requires sacrificing some spending.

US consumers have also leaned on their pandemic-fueled savings. Pandemic-relief money from the government and spending that people skipped early in the pandemic resulted in a national savings war chest of about $2.1 trillion, according to a Federal Reserve Bank of San Francisco study. Those savings are rapidly being spent and are currently estimated to have dropped to just $190 billion. Without a more balanced relationship between spending and income growth, these savings could be wiped out by the end of the year.

Further evidence of an increasingly stretched consumer can be seen elsewhere. Hardship withdrawals from 401(k) accounts have jumped, retail theft is spiking and retailers report that consumers are increasingly focused on discount brands.

None of this bodes well for future spending, nor do the mandatory student loan repayments set to resume in October. Indeed, following a three-year hiatus, millions of Americans will have to start diverting a part of their monthly paycheck back to these payments. This could potentially lead to a spending cut of about $9 billion per month, increasing the probability of recession.

How do Americans feel with all this going on? Not that great. Consumer confidence dropped in August, erasing most of the gains seen over the summer period. Worries about future employment are rising, as are concerns about incomes and finances. Consumers’ assessment of their present situation fell, as did their future expectations. Indeed, the index that tracks expectations fell to just above 80, which indicates that recession may be near.

As we approach the end of the year, we’ll continue to see mixed data, some stronger and some weaker. But the balance will most likely shift toward the latter. Income growth will continue to cool, savings will fall and debt will rise, and eventually the US consumer will have to pull back. A brief recession is the most likely outcome.

The-CNN-Wire
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