US Economy slow down shown through speeding car with US economy written on it with parachutes trying to slow it down

The Gross Domestic Product (GDP) growth numbers achieved by the US over the last year certainly surprised the market. There had been broad-based consensus among market participants that the US would enter a recession as a result of elevated interest rates and their impact on economic activity. The typical monetary policy transmission mechanism should have a meaningful impact on demand (i.e. consumption) and hence there were various risks to GDP growth given that consumption makes up around 70% of the US economy.

As we head into the second quarter of 2024, the broad consensus is that not only will the US economy avoid a recession (no “hard landing”) but also that there will be no material slowdown at all (no landing). In this first of two articles on the subject, we interrogate this position and look at some of the risks relating to potentially weaker economic growth in the US relative to the key drivers of economic activity in the US last year.

Chart 1: US real GDP growth history and expectations

US Real GDP grwoth percentage chart

Date sampled: 14 Mar 2024
Source: Investec Wealth & Investment, Bloomberg

In chart 1 above, we look at the history of real GDP growth in the US, the inflation-adjusted rate of growth. Over the coming two years, market participants expect US economic growth to slow from 2.5% in 2023 to 2.1% and 1.7% in 2024 and 2025. Only after 2025 is economic activity expected to rebound somewhat.

Chart 2: Growth among the various components of GDP (for the US)

: Growth among the various components of GDP (for the US) % chart

Date sampled: 15 Mar 2024
Source: Investec Wealth & Investment, BEA

The departure point for the overall discussion lies in unpacking the various components of GDP, as defined under the expenditure approach of GDP (consumption + investment + government expenditure + (exports - imports)). As chart 2 reveals, the key drivers of GDP growth in 2023 were exports (+2.7%), government expenditure (+4%) and consumption (+2.2%), while the drags on US economic activity were investment and imports. Unpacking those drivers and the current macroeconomic environment in the US leads us to ask the following questions on how they might perform in 2024:

  1. What could happen to consumption? Elevated interest rates and their lagged effects on consumption could continue to filter through the system. Inflation expectations suggest a more subdued consumption environment. Remember, consumption makes up around 70% of the US economy, and any material changes to consumption would have a material impact on economic activity in the US.
  2. What could happen to government expenditure? We may be approaching a more fiscally constrained environment in the US, driven by high debt levels (in a slower growth environment) and weaker corporate profitability, implying lower tax collection.
  3. What could happen to exports and imports? There is broad consensus that growth is set to remain slow among the US’s major export partners, in particular Europe, which presents some near-term risks to US exports. The slowdown in the US similarly presents a risk to imports as a function of lower demand. The expected weakness of the US dollar should also have an impact on exports.
  4. What could happen to gross fixed capital formation (i.e. investments)? Gross fixed capital formation by the private sector and government has been below trend over the last two years and in the last quarter of 2023 breached the long-term trend.

Next, we delve deeper into government expenditure and net exports. We will cover consumption, which makes up 70% of the US economy, in the next edition.

On government expenditure

Chart 3: US debt-to-GDP

US debt-to-GDP % chart

Date sampled: 22 Mar 2024
Source: Investec Wealth & Investment, FRED

Chart 3 above illustrates the extent to which the US economy could be fiscally constrained over the coming few years. Debt-to-GDP, outside of the Covid-19 pandemic period, is at its highest levels in history. Elevated debt levels imply that the US government will have limited capacity to increase bond issuance, particularly in an environment where growth is set to slow from 2.5% in 2023 to 2.1% in 2024.

Chart 4: US interest outlays as a percentage of GDP

Federal Outlays chart

Date sampled: 22 Mar 2024
Source: Investec Wealth & Investment, FRED

The first concern is best illustrated in chart 4 above, which looks at US government interest payments as a percentage of GDP. Higher debt levels similarly mean that the US is spending more on interest payments, limiting the space to spend on other items. This is negative for GDP growth because, given that government expenditure is a component of GDP, lower expenditure should translate into lower potential GDP growth. This is an area of concern and a key downside risk to GDP growth.

Chart 5: Growth in US Federal government receipts and outlays

Growth in reciepts and outlays chart

Date sampled: 15 Mar 2024
Source: Investec Wealth & Investment, White House

Chart 5 above shows the expected trends for growth in receipts (revenue) and outlays (expenditure). Outlays growth is expected to be materially lower than receipts growth over the next five or so years – yet another reason to be cautious about the impact of lower government expenditure on growth.

Receipts growth is also expected to be slow, and we refer you to the article we released last year on tax dynamics in the US: “What can governments do to support the economies in a slowdown?”. For the US, the main contributors to revenue (individual and corporate taxes) are expected to face several headwinds in 2024 driven by higher interest rates, slower wage growth and a potentially weaker labour market.

In summary, growth in government expenditure is expected to be weaker over the next few years, and the US government has limited capacity to issue more debt given elevated debt levels. In this environment, fiscal stimulus is unlikely to be a source for holding up the US economy.

On net exports (exports minus imports)

Table 1: Global GDP growth consensus estimates

Global GDP growth consensus estimates table

Date sampled: 07 Mar 2024
Source: Bloomberg, Investec Investment Management

For this section, we draw on the table above and highlight the growth expectations among the US’s major export partners. We also draw on US growth estimates as a proxy for the demand for imports and conclude with arguments about the relative impact of a weaker US dollar on exports and imports.

Chart 6: US’s largest trading partners

US largest trading partners bar chart

Date sampled: 26 Mar 2024
Source: Investec Wealth & Investment, USTR

According to the US’s trade representative, the major trade partners of the US are Canada (17%), the EU (just under 17%), Mexico (15%), China (7%), Japan (3.8%) and the United Kingdom (3.5%). These top trading partners account for the vast majority of exports, around 65%.

Chart 7: The relationship between US exports growth and US nominal GDP growth

US exports growth (yoy) chart

Date sampled: 26 Mar 2024
source: Investec Wealth & Investment, FRED

As shown in chart 7 above, changes in exports are typically positively correlated with changes in GDP growth. The chart implies that a fall in exports would result in lower nominal GDP growth in the US. Our assertion therefore is that, as slower economic growth takes hold, particularly in the EU, we would expect a negative impact on US nominal GDP growth.

GDP in the EU is expected to grow 0.5% this year, the UK is expected to grow by 0.4%, and Japan 0.7%. These jurisdictions account for around 25% of total US goods exports. This implies that slower growth in these areas, as a function of lower economic activity, may impact the relative demand for US goods. This is therefore a key area of concern when looking for potential headwinds for US economic growth.

It is also worth highlighting that the nature of the goods demanded (i.e. the price sensitivity of goods) in the various jurisdictions will determine the extent of the potential headwind from the slower growth (i.e. reliance on discretionary goods versus non-discretionary goods).

An additional consideration is the performance of the US dollar over the coming year. It is our house view that the dollar is expensive and may be due to some kind of correction (weakening) over the year (see chart below). The extent to which the US Federal Reserve can cut rates (the current expectation is for two cuts of 25bps each over the rest of the year, compared with the three cuts guided by the Fed), and the anchoring of US inflation (the Fed target is 2% and inflation is currently sticky at around 3%) will play a key role in how the US dollar performs this year.

Chart 8: Real effective exchange rate (USD)

Real broad USD chart

Date sampled: 14 Mar 2024
Source: Investec Wealth & Investment, Bloomberg

Charts 9 and 10: The impact of the US dollar on imports and exports

Charts showing the effect of the USD on exports and imports

Date sampled: 26 Mar 2024
Source: Investec Wealth & Investment, FRED

One might think that a weaker currency would be good for exports and bad for imports, however preliminary findings suggest that imports and exports have the same relationship with changes in the dollar.

Based on charts 9 and 10 above, a weaker dollar is good for both imports and exports. Therefore, a call on the relative performance of the dollar would not fully explain expectations about the performance of US imports and exports. Other than other factors such as supply chains, an important consideration is the correlation between the US economy and the global economy, with the performance of the US economy indicating the level of demand for imports, while the performance of the global economy would indicate the level of demand for exports.

Chart 11: The relationship between US and global nominal GDP growth

US versus world GDP (both nominal) chart

Date sampled: 26 Mar 2024
Source: Investec Wealth & Investment, FRED

The chart above shows that the US economy and the global economy are correlated. This implies that demand from the world (i.e. demand for US exports) is correlated with demand in the US (i.e. demand for imports).

Table 2: Regression on the relationship between exports and imports growth and US GDP growth

Table showing Regression on the relationship between exports and imports growth and US GDP growth

Date sampled: 26 Mar 2024
Source: Investec Wealth & Investment, FRED

The table above shows the relative importance of each of the variables (exports and imports) in explaining GDP growth in the US. The growth in imports has a more significant impact on nominal GDP growth as opposed to exports (a 1% change in imports has a more significant change in GDP growth than a 1% change in exports). This would be partially explained by the consistent trade deficits in the US.

In summary, the various moving parts highlight the inherent intricacies of forecasting the performance of exports and imports in the US and the relative impact of each on GDP growth. However, slower growth among the major export partners should imply weaker exports (as evidenced by a change in exports being positively correlated with US nominal GDP). This would be negative for GDP growth. The same is true for imports: slower nominal GDP growth would be negative for imports. Local and global growth are seemingly the main drivers of imports and exports, with limited impact on imports and exports from the performance of the US dollar.

So what does this mean for markets?

Chart 12: Earnings and GDP growth

Chart showing earnings and GDP growth

Date sampled: 14 Mar 2024
Source: Investec Wealth & Investment, Bloomberg

Chart 12 shows that in an environment where GDP growth slows – and we have highlighted some risks that the slowdown may be marginally more material than expected – we would expect US corporate earnings to come under pressure. Consensus estimates for earnings growth in the US may be somewhat optimistic: earnings are expected to grow around 12.2% this year.

Chart 13: The relationship between earnings growth and GDP growth slowing

Bar chart showing earnings and GDP growth

Date sampled: 25 Mar 2024
Source: Investec Wealth & Investment, Bloomberg

Another reason to be cautious about earnings expectations is the average level of earnings growth in an environment where GDP growth slows from one period to the next.

The US economy will certainly keep us on the edge of our seats over the company year, especially given the role it plays in the global economy. The US remains a key trading partner for South Africa, and an incrementally more robust economic environment in the US will be good for South Africa’s economic performance (particularly our exports should our logistics and energy situations improve).

In the next edition, we will unpack gross fixed capital formation (i.e. investment) and consumption (remember consumption makes up around 70% of US and GDP).

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