Inflation slows, but is the economy also decelerating? UBS: Six indicators reveal that the U.S. economy is declining

With only one day left until the U.S. election, the Federal Reserve's interest rate decision will also be announced this week. Meanwhile, the latest inflation and employment data have shown divergence, leading the market to focus on the upcoming economic trends. Will the prospect of a "soft landing" in the U.S. be realized?

In the latest U.S. Economic Outlook report, UBS analysts Jonathan Pingle, Pierre Lafourcade, and others stated that the current U.S. economy is slowing down, with rent remaining a major resistance against inflation, indicating that the current monetary policy is still restrictive. It is expected that the Federal Reserve is very likely to continue cutting interest rates in the coming period.

Specifically, UBS believes that six major indicators signal a weakening U.S. economy.

Slowing GDP Growth This Year

According to the report, so far, the annualized year-on-year GDP growth rate for the first three quarters of the U.S. averages 2.2%, a slowdown from 3.2% in the fourth quarter of last year.

Moreover, federal government spending and investment growth have both decreased by more than half. In 2023, as the fiscal deficit expands, its contribution to real GDP growth exceeds 1 percentage point, offsetting the impact of rising interest rates. However, as fiscal spending contracts, this economic boost is rapidly diminishing.

Deterioration of Ordinary Households' Balance Sheets

During the pandemic last year, the de-leveraging of American households and strong government support enhanced their balance sheets. However, as the impact of the pandemic fades and government support weakens, household balance sheets are beginning to struggle to support consumption behavior.

The report further points out that the wealth gap is exacerbating this phenomenon. Data shows that from 2005 to 2019, the top 20% of income distribution contributed an average of 38% to consumption growth. If the top 40% of income distribution is included, this figure approaches 60%.

This means that abundant stock market assets and liquid assets support the consumption of higher-income groups, while the balance sheet conditions of other ordinary households are deteriorating.

High Credit Costs Continue to Have Negative Effects

Data shows that the proportion of personal interest expenses in income has exceeded the levels of 2019.

UBS expects that the growth rate of credit card balances will slow down, and as the proportion of interest costs in income rises, the credit card delinquency rate will increase. More households may only be able to make minimum payments, leading to an increase in private business bankruptcy filings, and the credit environment may tighten over time.

Business Sector Remains Weak

The report cites media reports stating that overall intentions for capital expenditure remain low, hiring efforts are still weak, and PMI is also at a low level.

Data also shows that non-defense capital goods orders excluding aircraft have been "stagnant," new apartment construction has been declining, and the growth rate of multi-family housing, manufacturing plants, and public infrastructure construction is also slowing down.

UBS believes that without support from consumers and fiscal policy, the business sector may become even weaker in the future.

Labor Market Normalizing, but Growth is Slowing

Although the non-farm report remains strong overall, UBS finds that leading indicators of the labor market are still "mixed." This indicator began to deteriorate in September but has rebounded somewhat with subsequent data revisions; In the past four months, non-farm employment has averaged an increase of 114,000 jobs, with the private sector contributing only 75,000 jobs, which aligns with the trend of slowing growth.

Considering the "noise" caused by special factors such as hurricanes and strikes on non-farm data, UBS believes that this should not be "over-interpreted," as labor is either a fundamental trend of the market or indicates a slowdown.

Rent Remains the Main Resistance Against Inflation

Although overall inflation has improved, rent remains a major factor keeping inflation above the 2% target.

However, the report states that despite the rising costs of owner-occupied housing, apartment rent growth has significantly slowed, and rent growth is expected to further decelerate.

A Series of Rate Cuts from the Federal Reserve "Is on the Way"

Considering that inflation has significantly declined and is expected to continue cooling, while the labor market is likely to continue expanding, the recent interest rate decisions by the Federal Reserve indicate that it has returned to a neutral stance and is accelerating the pace of rate cuts.

The report predicts that the Federal Reserve will undertake a series of rate cuts, bringing rates down to near 3% by next summer.

UBS warns that if inflation returns to 2% or below, while the economy contracts, the Federal Reserve would typically prefer interest rates to be significantly below neutral levels, and a rate cut of more than 500 basis points is consistent with historical patterns; if the labor market weakens again, the Federal Reserve usually makes significant rate cuts in a short period.

In conclusion, UBS summarizes that the U.S. economy is slowing down, and the labor market is also slowing, with inflation expected to fall within the target range by 2025. Further rate cuts seem very likely, and the Federal Reserve appears to be responding by accelerating the pace of rate cuts