Introduction

Even with the possibility of a fourth-quarter slowdown in consumer spending, positive data across the board suggests the U.S. economy is still on track for a soft landing.

----- Transcripts -----

Ellen Zentner: Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief U.S. Economist. 

Sarah Wolfe: And I'm Sarah Wolfe, also on Morgan Stanley's U.S. Economics Team. 

Sarah Wolfe: And today on the podcast, we'll be discussing our updated U.S. economic outlook for the final quarter of 2023. It's Thursday, September 21, at 10 a.m. in New York. 

Sarah Wolfe: Ellen, since early 2022, you and our team have had a conviction that the U.S. economy would slow without a crash and experienced a soft landing. We maintained that view in our mid-year outlook four months ago, but we've recently revised it with an expectation for even stronger growth in the U.S.. Can you highlight some of the main drivers behind our team's more upbeat outlook? 

Ellen Zentner: Yes, so I think for me, the most exciting thing about the upward revisions we've made to GDP is that there's a real manufacturing renaissance going on in the U.S. and according to our equity analysts, it is durable and organic. So it's not just being driven by fiscal policy around the CHIPS Act and the IRA, but this is de-risking of supply chains, it's happening across semiconductors, our industrials teams have noted it, our construction teams and our LATAM teams around what's going on in terms of on-shoring, nearshoring with Mexico being the biggest beneficiary. So I think that's a really exciting development that is durable and then the consumer has been more resilient than expected. And I know that, Sara, you've been writing about Taylor Swift effect, Beyoncé effect, Barbenheime, you know, and it's just added to a very robust consumer this year than we had initially expected. 

Sarah Wolfe: Ellen, and what about inflation? What role does inflation continue to play at this point? Is the disinflationary process still underway and what are our expectations for the rest of this year and next? 

Ellen Zentner: Yes, So I think the disinflationary process has actually played out faster than expected. Well, let me say it's coming in line with our forecast, but much faster than, say, the Fed had expected. And we do expect that to continue. I think some of the concerns have been that the economy has been so strong this year and so would that interrupt that disinflationary process? And we don't think that's the case. The upward revisions that we've taken to GDP that reflect things like the manufacturing renaissance also come with stronger productivity, and they're not necessarily inflationary. But Sara, since your focus is on the U.S. consumer, let me turn it to you and ask you about oil prices. So oil prices have rallied here, you've spent a good deal of time looking at the impact that rising prices might have on real consumer spending, so how do you go about analyzing that? 

Sarah Wolfe: You're correct. Energy prices do impact consumer spending and in particular, when the price jumps are driven by supply side factor. So supply coming offline, that acts like a tax on households and we see a decline in real spending. We in particular see real spending impacted in the durable goods sector and in autos in particular. We have seen quite a rally recently in oil prices. It's definitely not to the extent of what we saw last year, but what we're going to be watching is how sustained the rally in oil prices are. The higher prices stay for longer, the more it impacts real consumer spending. 

Ellen Zentner: So retail sales have been strong, when are they going to be slowing? I mean we're going into the fourth quarter here, all on the consumer it looks like it's been stronger than expected. And I know this is sort of a maybe too broad of a question, but are consumers still in good health? 

Sarah Wolfe: As you mentioned earlier, consumer spending has been more resilient than expected. In part, it's been due to the fact that we've seen a full rebound in discretionary services spending, but it was not paired with a one for one payback in discretionary goods, which we've seen in the retail sales report, have held up better. And so while the consumer remains fairly healthy, we do expect to still see that pretty notable spending slowdown in the fourth quarter and part of that is being driven by the fundamentals. We have a cooling labor market, a rising savings rate, higher debt service obligations. But then as you also mentioned earlier, we had the roll off of some of these one off lifts like Barbenheimer, Beyoncé and Taylor Swift. 

Ellen Zentner: So why doesn't the consumer just fall off a cliff then? 

Sarah Wolfe: Because part of our big call for the soft landing is that the labor market is going to be relatively resilient. We do have jobs slowing, but we do not have a substantial rise in the unemployment rate because we think this labor hoarding thesis is going to help support the labor market. So at the end of the day, while there's pressure mounting on consumer wallets, if they have a job, they will continue to spend, though at a slower pace. 

Ellen Zentner: All right. So if labor income and healthy job growth is the key to consumer spending, you know, what are we telling investors about the UAW strike? Because that really muddies the picture for how strong the labor market is. 

Sarah Wolfe: The UAW strike is definitely worth watching, there's 146,000 union workers that work for the big three. At this point, the impacts should be fairly contained, we only have 13,000 workers on strike at three different plants. However, if we see a large-scale strike of all the union workers, that lasts for some time, I mean that's definitely going to take a hit to the labor market. It would be a one off hit because when the strikers come back, you see them re-added to payrolls. But it definitely will be a more sustained hit to economic activity and motor vehicle production. It's very hard to make up all the production that is lost when workers are on strike. So we're definitely watching this very closely and it's definitely a risk factor to economic growth in the fourth quarter. Ellen, I'm turning it back to you, with all these various factors in play has anything changed in our Fed path? 

Ellen Zentner: No, it hasn't. In fact, as the data comes in and what we're looking for ahead, it tells me even more so that the Fed is done here. So they're sitting on a federal funds rate of 5.25% to 5.50%, and there are a lot of pitfalls possibly ahead with the incoming data. So you have GDP benchmark revisions, which will be significant by our estimate, that are released on September 28th, so later this month. Two days later, government shutdown possible. You talked about the UAW strike that's gonna, again, muddy the picture for job gains. And so there's a lot on the horizon here. You know, in the environment of inflation falling and question mark around how much policy lags still have to come through, I think it's just a recipe for the Fed to go ahead and hold rates steady and so we think that they're done here. All right. So we'll leave it there. Sarah, thanks for taking the time to talk. 

Sarah Wolfe: As always, great speaking with you, Ellen. 

Ellen Zentner: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.