By Chris Kuehl, managing director, Armada Corporate Intelligence
J.K. Galbraith was a noted economist from Canada and famous for his pithy quotes. One in particular sums it up. He said, “The sole purpose of economic forecasting is to make astrology look legitimate.” It has been a rough year for those in the prognosticating business. There was an expectation of recession last year, with predictions of quarterly growth rates in decline. Instead, businesses saw growth rates at 2.1% for the first quarter, 2.1% again in the second quarter, 4.9% growth in the third quarter and 3.4% in the fourth quarter. Some thought that the long-expected downturn started to manifest in the first quarter of this year when the numbers fell to 1.6%, but in the second quarter there was a bounce back to 2.8%, and right now, the expectation for the third quarter is close to 3.0%. No recession in sight… and everyone at the Fed still talks about a soft landing. The economy still is being propelled by consumer spending (mostly by the upper-third of income earners), non-residential construction activity and the continued flow of government money. By most accounts, there will be a decent fourth quarter as long as those in the upper third of income earners keep splashing money on services.
Inflation Triggers
Inflation is measured in a number of ways. The media likes to refer to the Consumer Price Index (CPI) as it is current and released on the first of the month. The problem is that the CPI is a bit speculative as it is based on assumptions. The Fed uses Personal Consumption Expenditures (PCE) – what we actually bought and what it actually cost. The problem is that it takes about two months to collect that data and thus the PCE lags. The rate the Fed sees right now is 2.3% and that is very close to its goal of 2.0%. This is what allowed the drop in interest rates.
Another aspect of the inflation issue that vexes analysts is that it appears people equate the rate of inflation as the same as overall inflation. There are plenty of complaints about high prices, and that leads to skeptical remarks about an improvement in inflation. The point: It is the rate that has slowed, and inflation is not getting worse. The problem is that only two things bring inflation back down. The first is a brutal recession that brings business failures and high rates of joblessness. The second is competitive pressure as businesses try to lower prices to win market share. The first option is brutal, and the second is slow. The bottom line is the inflation experienced over the last few years will be present for a while.
Interest Rates
The initial trigger has been pulled: The Fed elected to go with a half-point cut rather than a quarter-point. Now the question is, “What happens next?” Does this cut become the first of many more? Most analysts suggest that another quarter-point reduction will be seen in December and that there will be more quarter-point cuts in 2025. The goal for the Fed seems to be rates between 3% and 3.5%, but there is disagreement over how soon that would take place. Central banks have a mantra to raise rates until they break something and then lower rates to fix what broke, all in the name of lowering the rate of inflation. The measures of whether they broke anything generally are unemployment and quarterly growth. It can be argued that the Fed did not break anything with those rate hikes. There has been solid quarterly growth through 2023 and into 2024, and the jobless rate has been sitting at 4.3% (the normal jobless rate is thought to be 6%). The talk from the Fed is about the soft landing, and the hawks on the Open Market Committee urge slow movement on rates.
Unemployment Rates
The rate of joblessness remains well below average. It has been a long time since the unemployment rate was 6%, but that still is considered “normal.” The recent job numbers have been weak, but they recently surged. The rate has moved from under 4% to around 4.3%, but the movement that has the Fed worried is in U-6, as it also has moved up. It still remains lower than in past years but has been gaining, and every time that has occurred there has been some kind of economic retreat.
Industrial Production
The latest data on industrial production has continued to trend in a positive direction. This has been fairly close to the long-run average – only off by 0.9%. The bottom line is manufacturing has remained healthy, as there appears to be continued demand for inventory build. There are a few motivations for expanded industrial activity, and these are based on some trepidation regarding the future. There is the fear that government support through the Inflation Reduction Act might end in 2025. That also encouraged manufacturers to act early and be ready for a possible retreat next year.
The same issues still affect manufacturing, and little progress is expected in the coming year. The top of the list is the worker shortage. By 2030, the entire Boomer generation will have reached the age of retirement. It is not that all of them will be leaving the labor force at once, but most of those in manufacturing and construction are ready to quit by 65. The level of workforce participation is as low as it has been since the 1970s. It stands at 61.6% and is dropping. The issue for the industrial community is that there are few replacements for those who are leaving.
The second issue is the supply chain. The system of Just-In-Time is in shambles, and most companies have returned to the practice of holding a lot of inventory. This certainly is making it possible to accommodate the needs of the customer, but inventory levels are high compared to past years and that is expensive. It also has required the construction of more warehouse and storage space.
The third issue is related to inventory build – overall, logistics have become more expensive and less reliable. The transportation sector has been overloaded by the expansion of online purchasing, and most of the industry has been unprepared. The parcel companies like Fed-Ex, UPS and Amazon are booming, but the traditional trucking industry has been negatively affected as there has been a decline in the kind of shipping that dominated before the online boom.
The fourth issue revolves around trade. The pattern of the past was simple enough – produce or source in China and then deliver to US users. As the US has tried to protect its domestic producers and reduce the level of dependence on China, there has been a series of tariffs and restrictions put in place. That alters the patterns, and many seem to forget that a tariff ultimately is paid by the consumer of that product. Some in the US can pass that cost on, but many can’t.
The fifth issue is the same one facing business in general, asking the questions of: “What is the prospect for an interest rate cut, and what happens with the coming election?” There is potential for a radical shift in governmental priorities.
Conclusion
The leadership in the White House and Congress will have the same set of challenges that existed in the last year. They also will face the same limitations. There are no quick-fix solutions to inflation, worker shortage or trade challenges. The economy will depend on the spending habits of the upper-income consumer and the continued confidence of the middle-income consumer. This latter group will keep spending as long as jobs are secure. n
Chris Kuehl is managing director of Armada Corporate Intelligence. Armada executives function as trusted strategic advisers to business executives, merging fundamental roots in corporate intelligence gathering, economic forecasting and strategy development. Armada focuses on the market forces bearing down on organizations.
More information: www.armada-intel.com
