Momentum Holds but Economic Uncertainty Rising
Sometimes I like to think of the macroeconomy as an oceangoing container ship. There’s a lot of mass in those ships, a lot of momentum. The largest of these ships are nearly 450 yards long and 180 yards across. They can hold nearly 24,000 twenty-foot-long shipping containers. Their sheer size allows them to survive storms that would sink smaller ships. They tend to move slowly, and you can’t exactly parallel park. Once they get moving, though, they don’t want to stop.
The US economy is in containership mode right now. The FED has raised rates by 525 basis points (i.e. 5.25%) in the last eighteen months, core inflation has been above 4% for nearly two years, multi-decade highs in mortgage rates and commercial vacancy rates, a worrying slowdown in China, and chaotic energy and commodity prices due to war in Ukraine. A container ship, Mike Mulligan’s steam shovel, or whatever other metaphor suits you, the US economy is not slowing down for now.
During our first quarter issue, we reported that growth appeared to be slowing at the national and state levels. Growth had been slowing at the national level for a few quarters. Growth had remained above 2%, but the trend was softening. At the state level, real growth had been negative for the last three quarters, and the state finished the year up only 0.5% over the prior year.
The US economy grew at an annualized rate of 2.0% during the first quarter, and most consensus forecasts put second-quarter growth in the 2.0% to 2.4% range. At the local level, South Dakota posted very strong 10.1% annualized growth in the first quarter due to a strong rebound in the Ag sector, which had a difficult fourth quarter in 2022. South Dakota’s second-quarter numbers will almost certainly fall back to earth, but the steady employment growth and solid hiring numbers indicate growth will remain positive as long as the Ag sector holds out.
In response to the solid first-quarter growth numbers, we are revising South Dakota’s 2023 growth forecast up from 0.8% to 1.2%. We are also revising our national growth forecast up from 1.1% to 2.0%. We are watching out for disruptions in the commercial real-estate sector and potential government shutdowns later this year. Either development would negatively impact growth, though the full effects would not be fully felt until 2024.
The continuing moderation of inflation pressures helps to buoy our growth outlook as well. Overall inflation, as measured by the growth in the CPI, declined rapidly in the second quarter, falling from 5.8% in the first quarter to 4.1% in the second. The FED’s actions are clearly having an impact, though we expect broad CPI inflation to remain above 3% through the end of the year. On the other hand, Core inflation (CPI less food and energy) remains stubbornly high and will have a greater impact on FED policy than the broad CPI measure. The Core CPI indicated 5.2% price growth in Q2 2023 compared to one year prior, down from 5.6% in Q1. We expect core inflation to remain above 4.0% throughout the year.
In the battle to tap down inflation, the FED has aggressively raised the Federal Funds target rate since March 2022. There was a pause in June 2023, but the Fed raised its target rate to 5.5% in July 2023. The FED has also clearly messaged its preference for another rate increase before the end of the year. It seems almost certain that there will be another increase at the September meeting. Further increases may follow, but concerns about the commercial real-state sector and government shutdowns may lead the FED to pause again before the end of the year.
Finally, mortgage rates have continued to rise through the second quarter. Average mortgage rates crossed 7.0% again in early August. During the week of August 24th, average rates reached 7.24%, levels not seen since 2001. We are revising our forecast for the year in light of developments over the last quarter. We now forecast rates to hit 6.90% during the third quarter before falling slightly to 6.65% by year’s end.