Soft Landing: Why the US economy will avoid recession and how it will affect the dollar

In the second quarter of 2023, US GDP grew by 2.4% compared to the same period last year. This is well above forecasts, which came as a surprise to the markets.

Now, the US economy is forecasting a “soft landing” scenario – a decrease in inflation without significant consequences for GDP dynamics.

US economy is growing better than expected

According to the results of the II quarter of 2023, US GDP grew by 2.4% in annual terms, according to the data from the Bureau of Economic Analysis. This is significantly higher than analysts polled by Reuters (1.8%) predicted, and more than real GDP growth in the first quarter of this year (2%).

US GDP is growing amid one of the most aggressive Fed rate hike cycles. Since March last year, the US financial regulator raised the base rate from 0-0.25% to 5.25-5.5%, the highest level in the last 22 years.

Raising interest rates in a country slows down lending, which usually has a downward effect on both inflation and economic growth. Although inflation in the country is slowing down, the economy is still resistant to rate hikes.

As the WSJ notes, economic growth in 2023 is roughly in line with the growth rate of the US economy before the pandemic.

At a press conference on July 26 after the rate meeting, Fed Chairman Jerome Powell said that the base case for the Fed is not a recession, but a “noticeable slowdown in growth,” although a few months ago, economists at the Federal Open Market Committee (FOMC) were betting on a recession in the economy this year.

Read also: Impact of FOMC Decision on Crypto Market

Household consumption and budget spending

The main driver in the dynamics of GDP in the second quarter of 2023 was the increased consumption of households. In the II quarter, this figure increased by 1.6% in annual terms.

It was this indicator that provided almost half of the total GDP growth. Household demand is boosted by a strong labor market and gradual wage increases, said Rubila Farooqi, chief US economist at High Frequency Economics.

The most recent data from the Labor Department shows that initial claims for state unemployment benefits fell by 7,000 to 221,000 in the week of July 15-22. This is the lowest level since February this year.

After household consumption, the contribution to GDP growth is followed by investment in fixed capital and government spending.

Investments in annual terms increased by 7.7%, and government spending – by 2.6%.

The growth in government spending is largely associated with state support programs for certain sectors of the economy, as well as interest expenses, said Yegor Susin, Managing Director of Gazprombank Private Banking.

He added that interest spending on servicing the public debt in the US for the second quarter hit a new record of $970 billion, or 3.6% of US GDP. The budget deficit widened to about 8.4% of GDP over the same period.

In his opinion, against the backdrop of rising interest costs, the state will reduce support and incentive programs, which will negatively affect economic growth.

Why is it important

Accelerated GDP growth last quarter is working against the Fed’s efforts to reduce inflation, which could force the regulator to raise rates further, explains Bloomberg Economics economist Anna Wong.

Susin from Gazprombank Private Banking agrees with her:

Growthin household consumption and government spending may become a reason to further raise the Fed interest rate.

After meeting on July 26, the Fed raised the key by 0.25 percentage points, without clearly indicating whether further tightening of monetary policy is planned.

And the Fed chairman stressed that “stronger growth could lead to higher inflation over time, requiring an appropriate monetary policy response.”

Read also: Can Raising Interest Rates Truly Tame Inflation?

Against the backdrop of strong growth in US GDP, the dollar index (DXY) added almost 1.5%. The US currency is rising due to the fact that the chances of further rate hikes by the Fed are growing, Reuters points out.

The DXY index, which reflects the value of the dollar against six key currencies, has been gradually declining since the beginning of summer and by mid-July broke through the 100-point mark: this has not been seen since April last year.

Experts noted that the dollar was declining, among other things, due to the fact that the Fed’s aggressive policy is probably coming to an end.

Butthe resilience of the US economy should support the dollar after a prolonged decline in recent weeks, said Jane Foley, head of foreign exchange strategy at Rabobank London.

Read also: De-Dollarization: 3 reasons why USD is losing its dominance

Should I expect a soft landing?

Most of the economists polled by Reuters, after the release of US GDP data, predict that the country will face a “soft landing” scenario ahead: the Fed will be able to reduce inflation to target levels without serious consequences for the labor market and the economy.

If you’re looking for an up-to-date definition of the word ‘sustainability’, take a look at the American economy. It absolutely fits that definition, said RSM Chief Economist Joseph Brusuelas.

However, some experts remain skeptical about the US economy due to the cumulative effect of higher interest rates and the subsequent tightening of credit standards by banks. Stephen Ethan, global analyst at MarketsXplora predicts a shallow recession in the coming quarters.