Best’s News & Research Service - February 16, 2024 12:10 PM (EST)
AM Best: US Economy's Soft Landing May Experience a Bumpy Road
OLDWICK, N.J. //BestWire// - The economy performed well in 2023, but there are signs of a potential slowdown ahead, said Ann Modica, director, AM Best, referencing a new Best's Special Report.
Ann ModicaView the video version of this interview here.
Following is an edited transcript of the interview.
The U.S. economy's recent performance has significantly reduced the possibility of a recession in 2024. However, a new AM Best report notes that growth is still set to slow.
Q: Do you remember what we were talking about this time last year? Dire predictions of a recession, fresh off a flurry of rate hikes. So, how would you characterize 2023?
A: So, by almost any measure, the U.S. economy performed better than predicted last year. If we were to take a time machine and look at the start of last year, the Wall Street Journal Economic Forecasting Survey put the odds of a U.S. recession at 61%. So, not only did we not enter a recession, but GDP growth was above trend and ended up at 2.5% for the year. Growth was mainly driven by domestic consumption, which accounts for about 70% of total GDP, and consumers continue to be supported by a strong labor market.
Additionally, real wages turned positive in the second half of the year as inflation continued to moderate. There was a positive wealth effect with the rise in the stock and housing markets. Government spending was also a positive driver.
But somewhat more interesting, I think, is it also appears that the transmission mechanism of monetary policy has been weaker than it had been in previous cycles, with households and businesses appearing to be somewhat less interest rate sensitive to the Fed rate hikes.
Both took advantage of the previous cycle low rate environment. A majority of consumer debt is fixed and businesses have pushed out the duration of debt maturities alleviating some of the immediate pressures from higher rates.
Q: Now you mentioned inflation moderating last year and there was so much talk of inflation. Should we expect the inflation to be moving in the same direction this year?
A: So, yes. The Fed had made significant headway in its battle against inflation in 2023, but it's not at its target yet. It does continue to move towards the Fed's target at 2% and I would expect it will continue to fall in 2024. If we just take one measure of inflation, if we look at headline inflation, we can see that it started the year in 2023 at 6.3% and ended the year at 3.3%.
One category of inflation that is expected to come down this year is shelter inflation, which is huge because it's the largest weighting in the CPI index at almost 40%. Shelter inflation ended the year at 6.2%, which is a year over year growth which is more than double it's historical average. It kind of sounds like bad news, but it started to come down from its peak in May of 8% and I would expect that this would come down further because shelter is a lagging indicator. Leases renew typically on an annual basis, so it does take some time for those price changes to cycle through.
So, while I'm largely positive that inflation will continue to fall into 2024, there's always some downside risks, right? The various conflicts around the world have the potential for supply chain disruptions and commodity price shocks, which all could lead to higher prices.
Q: You know, we've been hearing so much about the tight housing market. To what extent do these factors impact housing?
A: So, you know, higher mortgage rates and the elevated home prices continue to negatively impact the housing market. Sales hit in a nearly three decade low last year. While housing prices only increased moderately in 2023, prior appreciation kept home prices really high. According to the Federal Reserve Home Affordability Index, which looks at home affordability on three metrics, interest rates, prices as well as income, affordability is close to an all-time low.
While the appreciation in prices and high rates has played a large part in the lack of affordability, so has a lack of inventory. While the lack of housing inventory is not a new problem, it has been exacerbated by the large differential in mortgage rates pre- and post-pandemic.
Most current homeowners are rate locked. With mortgage rates much lower than the current prevailing rate, and this is creating a huge disincentive for homeowners to move from their current home if they need to finance for a new home at a higher rate.
Q: Looking ahead through the remainder of 2024, what sort of economic picture should insurers expect?
A: I think economic activity will slow in 2024, but I think there's a very low risk of recession. If there were to be one, I think it would be short and shallow. Some of the factors that I'm looking at this year is, I do expect there to be a slowdown in consumer spending. Labor markets are expected to moderate, unemployment might tick up slightly, but this is from a historically low base. We have seen some negative factors with regards to higher revolving credit lines, lower savings rates, and delinquencies are starting to tick up, and this is particularly true for younger and lower income households.
I also think there's going to be more economic uncertainty with regards to the upcoming elections in November. We also have an elevated degree of worldwide geopolitical tensions around the world that could also cloud economic outlook for both growth and inflation.
And of course, there's the Fed, right? All eyes are on them this year and what their plans are in reducing rates. The Fed did take a dovish tone in December, signaling they would cut rates by 75 basis points this year. Markets at the same time, priced in double that amount of cuts. But so far, the Fed has really stood their ground, signaling they are in no hurry to cut rates, and markets have slightly pulled back on their projections for the early timing and the extent of cuts.
I do think some of the more recent positive economic data makes it less likely the Fed will cut in March, but I guess time will tell. It should be an interesting year.
You can find the full report online at ambest .com.
View this and other interviews at http://www.ambest.tv
(By John Weber, senior associate editor, AM Best TV: John.Weber@ambest.com)