Is economy out of the woods?

The government recently reported unambiguous good news for the economy: The rate of inflation has slowed significantly. The Consumer Price Index (CPI) grew at an annual rate of 3% in June, the smallest increase since March 2021 and well off the peak rate of 9.1% seen in June 2022 (9.1% was the fastest annual rate since November 1981).

The core rate, which strips out the volatile categories of food and energy, increased by 4.8%, the lowest core inflation has been since October 2021 and a significant improvement from its recent peak level of 6.6% in October 2022.

A big contributor to the overall drop in CPI was energy, which has tumbled 16.7% since last year, led lower by a near 27% plunge in gas prices. (The energy component spiked primarily due to the war in Ukraine and pandemic-related supply chain issues, which caused the average price for a gallon of regular gas to soar to more than $5 in June 2022.)

The combination of those issues receding, and the Fed’s aggressive rate hike campaign, where the central bank increased short-term lending rates five full percentage points over the course of 15 months starting in March 2022, have made a big dent in the rate of inflation.

Despite the improvement, I continue to hear from people who say things like, “But everything is still so expensive!” Of course, some things cost a lot more than they did prior to the pandemic, like housing prices, childcare and car insurance, not to mention some of the still sky-high prices on menus.

That said, even though we complain, surveys find that the drop in prices is making a difference in how we feel. The University of Michigan’s Consumer Sentiment Index rose in July to its “most favorable reading since September 2021 ... The sharp rise in sentiment was largely attributable to the continued slowdown in inflation along with stability in labor markets.”

The improvement in prices and sentiment begs the question: Is the U.S. economy out of the woods?

We started the year with economists and analysts almost uniformly predicting that the economy would fall into a recession in 2023, but it most certainly has not done so yet.

Gross Domestic Product (GDP) expanded at an annualized pace of 2% in the first quarter of the year, and estimates for the second quarter range from about

1 to 2.3% annualized growth. Those early recession calls presumed that the labor market would roll over, which it has not. Despite job losses in tech, banking and media, the resilient labor market has seen 30 consecutive months of job growth.

However, the Federal Reserve is concerned that further progress on inflation may not be forthcoming, as the yearover-year comparisons will be tougher in the second half of 2023. The central bank’s view does not sync up with a likely improvement in the shelter component of the CPI, a major contributor to headline and core inflation rates, but fed officials are the deciders, and they have indicated that another rate hike is probably coming, perhaps as soon as at the end of this month.

One or two more rate hikes, along with a general slowdown in economic data, could mean that a recession is still possible.

Analysts at Capital Economics warn: “June’s soft U.S. CPI print seems to have given investors renewed hope that inflation could fall back to normal levels without the economy slowing too much, if at all. We continue to think that the chance of a more significant economic slowdown is underappreciated.”

So, is the economy out of the woods? Maybe ...