The Goldilocks Scenario: Sustaining Economic Growth Amid Mounting Pressures
The Goldilocks scenario refers to an ideal economic situation where the Federal Reserve successfully controls inflation without sacrificing employment and where GDP growth remains positive. This article examines the factors contributing to the current Goldilocks scenario and explores potential challenges that may lie ahead and what this means for investors.
Sustained Consumption and Household Excess Savings
Figure 1. Personal Consumption contribution to % change in real GDP. (Source: St. Louis Fed, 2023.)
Figure 2. US Household Excess Savings. (Source: Adam Button, ForexLive, 2023.)
One of the key factors supporting current US economic growth is personal consumption, which has consistently contributed to GDP growth. The graph above shows that consumption generally adding around 1% to 1.5% to GDP growth over the past year. Additionally, household excess savings have played a facilitative role. The generous fiscal measures e.g. accomodative tax breaks used by the US government during the pandemic sustained the income of US households, even as their spending collapsed, leading to an accumulation of excess savings. As depicted in Figure 2, excess savings have steadily decreased from their peak in mid-2021, indicating that they have been utilised to sustain economic activity. While there is still a fair amount left, it is important to recognise that this reserve will eventually be depleted.
Declining Savings and Rising Credit Card Usage
The recent decline in the amount people are saving and the increase in consumption through credit cards reveal the extent to which consumers are driving economic growth. The amount consumers are saving as a percentage of their income, better known as savings rate, has dropped significantly. This indicates that consumers are spending a larger portion of their income. The amount of credit card debt has risen in tandem, suggests consumers are fueling their spending through borrowing. While there is further room for expansion in credit card spending, savings rates have reached their lower limits. This paradigm raises concerns about the sustainability of growth if consumer debt starts to approach levels that impose unaffordable debt servicing costs on households.
The Inflation Reduction Act and its implications
Figure 3. The growth of the Inflation Reduction Act ($bn). (Source: EATON, 2023.)
The Inflation Reduction Act has also played a role in sustaining economic growth. Spending resulting from the Act has surpassed initial projections, primarily due to uncapped tax credits and subsidies in some of the sub-programs within the Act. This flexible structure allowed companies to access subsidies if they met the eligibility criteria. Consequently, the Inflation Reduction Act has ballooned in size, creating a larger than expected boost to economic growth. From August 2022 to June 2023 the estimated size of the bill more than doubled, as firms showed unexpectedly high interest in making the investments that attract subsidies and tax credits. Moreover, the Act's unspent funds are set to provide continued support to growth. The majority of these funds have a spending deadline in 2031, suggesting a prolonged tailwind for economic expansion.
The Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act and Manufacturing Construction Spending
Figure 4. US Manufacturing Construction Spending by Industry. (Source: Joseph Politano, 2023.)
The CHIPS Act, aimed at bolstering domestic microchip production, has had a notable impact on US manufacturing construction spending. The construction of semiconductor fabrication plants has driven substantial growth in computer, electronic, and electrical manufacturing construction activity. This investment has created a positive multiplier effect, as workers involved in these projects spend their wages on various goods and services. The CHIPS Act has thus contributed to the overall resilience of the economy.
Cracks in the Goldilocks Scenario
Figure 5. Loan delinquencies. (Source: Washington Post, 2023.)
While the current economic conditions have been favourable, some cracks are beginning to show, particularly among the lowest-income Americans. Delinquencies are when borrowers stop payments on their debts for a period, but have not yet defaulted. This is the first step towards default and indicates rising financial stress among consumers. Delinquencies on auto loans, credit cards, and consumer loans have increased, signalling potential financial struggles for individuals at the lower end of the income spectrum. Although these delinquency levels are not as severe as those witnessed during the 2008 Global Financial Crisis and subsequent recession, the trend is concerning and highlights the growing challenges faced by consumers.
Economic Challenges in the UK and the EU
The economic challenges are not limited to the United States. Insolvency agreements and bankruptcies in both the UK and the EU have been on the rise. The increase in insolvencies among businesses and individuals indicates mounting economic pressures. While these levels are not as severe as those observed during recessionary periods, the direction of travel is clear, and credit quality is declining. It is often the case that economic stress appears first in the weaker peripheries and then in the stronger core. Given the more direct impacts of the Russia-Ukraine war, Europe can be seen as the weaker periphery to the stronger US core.
The Road Ahead
The Goldilocks scenario has thus far sustained economic growth, and there are indications that it may continue for several more months or even into the next year. However, signs of a slowdown and mounting economic pressures necessitate vigilance. Monitoring the evolving economic landscape will be crucial in identifying potential risks and then positioning portfolios accordingly.
The current Goldilocks scenario suggests a favourable economic environment characterised by falling inflation, low unemployment, and positive GDP growth. Factors such as consumption sustained by household excess savings, strong government spending, and subsidised high-tech manufacturing investments have contributed to the possibility of this scenario becoming a reality. However, challenges are emerging, including rising credit card debt, and increasing delinquencies among lower-income individuals. The economic landscape in the UK and the EU reflects similar concerns.
You might ask: what is the relevance of all this? Put simply, current positive equity valuations are pricing in this Goldilocks scenario, therefore if reality does not live up to expectations equity markets could suffer! As ever, we will seek to protect and grow your wealth whether the economy blows hot or cold.
If you would like to discuss any of the issues raised in this update then please feel free to contact your investment adviser, or if you're looking to get started and have £100k or more in investable assets, arrange your free initial consultation.
Note: This Market update is for general information only, does not constitute individual advice and should not be used to inform financial decisions. Additionally, past performance is not a guide to future returns. Investment returns are not guaranteed, and you may get back less than you originally invested.