Hello, everyone. I'd like to welcome you to today's Mid-Year Economic Update. Today's web seminar is being recorded, and you're currently in a listen-only mode.
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Now, without further delay, let's begin today's mid-year economic update. I'd like to introduce you to Gus Faucher, Chief Economist of the PNC Financial Services Group. Gus, the floor is yours.
Thank you very much, Ian. It's a pleasure to be here with everyone today.
So there's a lot of talk about recession in the US economy in mid-2022, but the economy is not in recession now. The economy continues to expand. There's a group called the National Bureau of Economic Research; they date recessions and expansions in the United States. And according to the NBER, a recession is a broad-based downturn in economic activity that lasts more than a few months. In mid-2022, consumers continue to spend more, businesses continue to invest more, businesses are hiring, job growth is solid. And so there is no recession.
Now, there are concerns about inflation. We have seen job growth slow in 2022. But overall, conditions are solid for the US economy and the economy continues to expand. We are about two years into an economic expansion. There was a very significant recession that occurred when the pandemic came to the United States, and government imposed restrictions on economic activity, but the economy has been growing for more than two years.
However, we have seen higher interest rates in the United States economy, particularly as the Federal Reserve has been raising rates in an effort to slow inflation. When the pandemic came to the United States in early 2020, the first thing that the Federal Reserve did was cut short-term interest rates. The blue line is the yield on a three-month Treasury bill, what it costs the Federal government to borrow for three months. And you can see that that fell from around 1.5% to 0% as the Fed got its Fed funds rate, its key policy rate, essentially to zero.
The Fed decided at that point that it needed to do even more to support the economic recovery, and so the Fed tried to push down long-term interest rates. The Fed purchased long-term Treasury securities; the Fed purchased mortgage-backed securities. And you can see that the yield on the 10-year Treasury note fell from around 2% in early 2020 to well below 1%. And for example, we saw the 30-year fixed-rate mortgage rate fall below 3% in 2020 as the Fed was pushing down long-term interest rates.
Now, as the economy has recovered, we saw long-term interest rates start to increase with stronger growth and higher inflation. And then more recently, the Fed announced earlier this year that it would start to reduce its purchases of long-term Treasuries, then ended them in the summer of 2022. And so we've seen long-term interest rates increase, so the yield on the 10-year Treasury note is now up to around 3%. And that fixed-rate 30-year mortgage rate is now around 5.5%, 6%.
Also in 2022, we've seen the Federal Reserve raise short-term interest rates. So the Fed funds rate, the Fed started to increase that in the spring. We saw a big increase in the Fed funds rate in June, and with that we've seen short-term interest rates -- for example, the interest rate on that three-month Treasury bill -- increase dramatically. It's now up to almost 2%. So we are seeing higher borrowing costs throughout the US economy as the Fed raises interest rates in an effort to cool off economic growth and bring down inflation.
And we've seen a stock market reaction as well, so the blue bars -- that's the S&P 500 -- that's a broad-based measure of stock prices in the US economy. You can see, first of all, that the S&P 500 fell dramatically with the pandemic. It's starting to recover in the spring of 2020, as businesses started to reopen as consumers felt more comfortable going out. And then we saw big stock market gains in the second half of 2020 and throughout 2021.
In 2022, we have seen a decline in stock prices. They fell by about 20% in the first half of this year as inflation concerns grew, as the Fed started to raise interest rates. Higher interest rates are bad for stocks as the recession fears have increased. And so, stock prices now are back to about where they were in early 2021, but still well above where they were prior to the pandemic.
Similarly, you can see the orange line on the right-hand scale. That's the PICS index. That's a measure of how much stock prices are moving up and down. You can see that we have an enormous spike in volatility when the pandemic came to the United States. Volatility remained elevated in the second half of 2020, and then in 2021 as we went through the election and stimulus and so forth. And we have seen an increase in volatility in 2022, again, with inflation concerns, with the Fed raising interest rates, but volatility is still well below where it was before the pandemic, just before the pandemic. It's well below where it was during the great recession from 2007 through 2009. So although the stock market is indicating concerns about US economic growth, it is not necessarily indicating recession in the US economy.
The biggest reason to think the US economy is not in recession right now is the labor market. We lost 22 million jobs during the pandemic, much larger than the job losses that we experienced during the great recession about 15 years ago, in a much shorter period of time. But since the worst of the pandemic, we've seen job growth bounce back. And in fact, jobs are now almost back to where they were before the pandemic, and I would expect that over the next few months we will see a new record high in employment in the United States.
Over the second quarter of 2022, we saw the economy add about 375,000 jobs per month on average. That's well above what the economy can sustain over the long run. It's well above the pace of job growth that we had prior to the pandemic. And it's very solid and indicates that businesses continue to hire, that they expect that demand will continue to improve, and that the economy is not in recession in mid-2022.
However, employers are facing a very tight labor market. The blue line here is the labor force participation rate. That is the share of adults who are either working or looking for work. You can see, first of all, that that has been falling over the long run. So it's fallen substantially over the past couple of decades as the Baby Boomers have retired and left the labor force. And then you can see the big drop in the labor force participation rate in 2020 as the pandemic came to the United States and many people dropped out of the labor force because they were concerned about catching the coronavirus, because they were parents of young children and their child's schools were closed or daycare centers were closed.
Now, you can see that the labor force participation rate has come back somewhat since then, but is still well below its pre-pandemic level. And a large part of that is because of people who are, let's say, in their 60s who were thinking of working for a few more years but when the pandemic came, they dropped out of the labor force and they have not returned. And I think that most of those people, at this point, will not be returning to the labor force. So the labor force participation rate is structurally lower now than it was prior to the pandemic.
And because of that, I think that the labor force struggles that businesses are facing in terms of finding available workers are going to persist, and businesses are going to need to think about this over the long run: how they're going to attract workers; how they are going to increase output with fewer available workers out there. Because I do think that the structurally-tighter labor force is going to persist over the longer run.
We see that the economy continues to expand in 2022, and in fact, economic activity is well above its pre-pandemic level. All of these numbers are adjusted for inflation, and I set the peak before the pandemic equal to 100. So for example, you can see real gross domestic product. That's the broadest measure of economic activity that we have. Output of goods and services, again, adjusted for inflation. That fell by about 10% in the first half of 2020 as the pandemic came to the United States, but has recovered quite nicely and in fact is above its pre-pandemic level.
And if you look at gross domestic income, the orange line, that's an alternative measure of the size of the economy. That looks at the income going to households and businesses from economic activity, adjusted for inflation. So it includes things like earnings from the labor market, return on investments, corporate profits, and so forth. That's about 5% above its pre-pandemic level, and has been growing strongly in 2022. So the economy, now, is substantially larger than it was before the pandemic, even with that big 10% drop in economic activity that we had in the first half of 2020 as the pandemic came to the United States. And you can see that the recovery from the viral recession in 2020 has been much stronger than the economic recovery than we experienced after the great recession from 2007 through 2009.
But the recovery, this time around, has been uneven. The blue bars are the change in economic activity between the fourth quarter 2019 before the pandemic and the second quarter of 2020 when things were at their worst. The orange bars are the change in economic activity between the fourth quarter of 2019, and then the latest review we have, the first quarter of 2022. And these numbers are, again, adjusted for inflation.
So you can see that consumer spending on services fell by about 15% from the fourth quarter of 2019 before the pandemic to the second quarter of 2020 when things were at their worst. These are the services that we purchased. These are things like education, healthcare, travel, tourism, dining out, personal financial services, and so forth.
Now you can -- you can't really see it here, but as of the first quarter of 2022, spending on services was just back to where it was before the pandemic. So deep contraction, and then a recovery, but has still only returned to its pre-pandemic level. On the other hand, if you look at consumer spending on goods, either durable goods, big-ticket items like cars and appliances meant to last more than 3 years, or non-durable goods, meant to last fewer than 3 years -- things like food, clothing, medications, gasoline, and so forth -- you can see that we had small declines there with the pandemic. But now, spending is well above its pre-pandemic level. And this helps explain the high inflation that we are seeing in the US economy currently.
We're buying a lot more goods now than we did before the pandemic. Our infrastructure isn't built to handle that. And so, that's contributed to that very high inflation that we are experiencing in mid-2022.
You can also see that services spending just barely back to where it was, goods spending well above where it was prior to the pandemic, which means that over the next couple of years we are going to see consumer spending growth shift from goods to services. So, services spending will be especially strong in the second half of 2022 and 2023. Goods spending will be weakened -- in fact, in many categories, we will actually see spending decline. So we are going to have a rotation in the US economy from goods to services, over the next couple of years.
Business fixed investment, this is investment in things like equipment, machinery, commercial construction, energy infrastructure, and also includes spending on things like software and R&D. You can see that that fell by about 10% initially with the pandemic. Businesses were uncertain about what was going to happen to the economy. But with strong economic recovery, with labor in short supply, one thing businesses can do to support output, if they can't find workers, is to make their existing workers more productive. And so we've seen a solid recovery in business investment.
Residential investment, this is things like homebuilding both single family but also apartments and condominiums. It also includes repairs and renovations. You can see that that fell by about 5% initially, now is up about 14% above its pre-pandemic level, with very low mortgage rates. Housing activity has been strong; home building, people have been putting on additions to their homes; they've been fixing up their homes. That's been very strong. But now that we see mortgage rates increasing, we will see a falloff in residential investment in the quarters ahead.
Exports, you can see that exports fell more than 20% initially, still down by about 8% from their pre-pandemic level. The recovery in other parts of the world has been weaker than in the United States, and so exports have yet to fully recover. On the other hand, look at imports. Those fell by about 20% initially, now about 15% above their pre-pandemic level. Many of the goods that we have been buying have been imported goods, both as consumers and as businesses. But again, it helps explain high inflation. It helps explain the bottlenecks that we're seeing. It helps explain late deliveries and so forth, because our infrastructure isn't built to handle this big surge in imports in such a short period of time.
And finally, these bars at the bottom, these are the key to the entire thing. After-tax personal income -- this is the income going to households from the labor market, from the government, from investments. And you can see that that actually jumped by about 10% between the fourth quarter of 2019 and the second quarter of 2020. Now, remember, we lost 22 million jobs over that period. We lost all the income associated with those jobs, but household income actually jumped. Why? Because the Federal government stepped in and provided stimulus payments to households. It made more people eligible for unemployment insurance. Gig workers, like Uber and Lyft drivers, the self-employed, independent contractors, the government also increased the level of unemployment insurance benefits. So even though we saw this huge decline in employment, we saw a big jump in household income.
And that's what's allowed people to make a down payment on a new home. That's what's allowed people to purchase a new car. And that really jumpstarted the economic recovery that we are seeing in the US economy. Now, you can see that after-tax personal income has actually fallen since then, as we've seen stimulus payments end, this extra unemployment insurance benefits have ended. But still, above its pre-pandemic level, even after adjusting for inflation. And so, consumer incomes now are higher than they were before the pandemic and consumers have a lot of money saved up.
So the blue line is the personal saving rate. That is the share of after-tax income that households are saving. You can see, first of all, that heading into this recession in early 2020, household saving was higher than it was heading into the great recession of late 2007. So, households were already better-prepared this time around. And you can see, those enormous jumps up in personal savings with the pandemic. What was going on?
Well, you had aid from the government, so you had stimulus payments. You had extra unemployment insurance benefits. And there wasn't anything that you could spend your money on. You weren't going out to the movies; you weren't going to the doctor; you weren't going out to eat at restaurants; you weren't going on vacation. And so, households drastically increased their savings in 2020/2021, and they still have a lot of that savings now. So even though now the personal savings rate has fallen to below its pre-pandemic level, households still have about an extra $2 trillion saved up in aggregate. Some households have gone through that savings. Others still have a lot of savings on their books. But in aggregate, households have a lot of money saved up which means that even with higher gasoline prices, higher food prices, higher overall inflation, then a household will be able to increase their spending in the second half of 2022 and then in 2023.
And so, consumer spending makes up two-thirds of the US economy, and so as long as households still have those extra savings that they can count on, as long as the job market is good, consumers will continue to increase their spending and the US economy will continue to expand.
Similarly, the orange line on the right-hand scale, that's the financial obligations ratio. That's the share of after-tax income that goes to mortgage payments, rents for renters, student loan payments, auto loans and leases, credit card payments, property taxes, homeowners' insurance, those types of things. You can see that that is very low right now. Consumer balance sheets are in excellent shape, certainly much lower than we had heading into the great recession back in 2006-2007, when households had piled on a lot of housing debt. So, households have refinanced their mortgages, they've paid off their higher-interest-rate debt. Some of it is due to things like student loan debt moratoriums and so forth. But generally, household balance sheets are in good shape which means, again, that even with higher inflation, households do have the ability to borrow to support their spending, particularly for big-ticket items. And that will be a support to consumer spending growth going forward.
Another support to economic growth in the second half of 2022, and then in 2023, will be the need to rebuild inventories. This is basically the inventory-to-sales ratio for the US economy as a whole. You can see that that is very low, particularly given the very strong demand that we are seeing in the US economy. And when I talk to businesspeople, they tell me that they could sell more, if they had more inventories on hand. And so, the need for businesses to rebuild their inventory will be a support to economic growth in the second half of 2022, and then again in 2023.
We have received enormous amounts of stimulus from the Federal government over the past couple of years. You can see, about $1.2 trillion in aid to small businesses, primarily through the Paycheck Protection Program, the PPP program. That made very low-interest loans to small and medium-sized businesses. For many of those businesses, those loans turned into grants if they were able to meet certain requirements, in terms of keeping workers on their payrolls and maintaining pay levels. And that allowed many small businesses to stay open through the worst of the downturn, and then, as the economy improved, to gradually resume normal operations. That's made a huge difference, and has allowed many small businesses to stay open and then continue -- and then expand as the economy is improved.
Stimulus payments, those are the stimulus payments that were sent out to households, about $800 billion. Aid to states -- states have not needed to cut their spending this time around. That's been a big support to economic growth and the economic recovery. Unemployment insurance benefits, more people eligible for unemployment insurance, higher benefit levels, those expired in September of 2021. But that's provided an extra $600 billion in aid to households. Imagine if all of those households that had unemployed workers had to cut back on their spending and the economic pain we would have felt.
Aid to big businesses -- aid to the airlines, aid to the travel industry, and so forth. That's been a big support. Healthcare spending to combat the recession and the pandemic, vaccine rollouts, aid to health systems and so forth -- that, again, has made an enormous difference, and this has really accounted for the economic recovery that we have seen over the past couple of years.
Now, you're probably saying to yourself, well, that's great. But can we, as a nation, can we afford that? My answer is, we couldn't have afforded not to do it. If you look at the orange line on the right-hand scale, that is debt held by the public, Federal government debt held by the public. That got up to about 100% of GDP, was near a record. Not quite the record that we saw in 1946 coming out of World War II. But the US economy faced an existential crisis in early 2020 when the pandemic came to the United States, and it's really been that aid from the Federal government that has made an enormous difference and has allowed the expansion that we are experiencing to get underway.
You can see on the blue line on the left-hand scale, that is interest payments on the Federal debt as a share of the size of the economy. That's actually much lower now than it was in the 1980s and the 1990s. Interest rates, although they've moved up, are still very low. Now, that blue line will move higher with the higher interest rates that we've seen in recent months, but still, with borrowing costs very low the Federal government has easily been able to fund its deficits. And so I'm not terribly concerned about a fiscal crisis anytime in the near future. We still need to make smart decisions about how the Federal government is going to spend its money, in terms of investing in infrastructure, national defense, payments to the Baby Boomers for their retirements, and what taxes we're going to levy.
But overall, the US fiscal picture is still pretty solid, and I'm not worried about a fiscal crisis anytime over the next couple of decades.
Obviously, inflation is a concern in the US economy. We have seen much higher inflation over the last couple of years for a few reasons. Very strong demand in large part because of stimulus from the Federal government. We've seen production difficulties in many parts of the economy, particularly with strong demand for goods. And then also, the Federal Reserve has kept interest rates low, and that has supported demand as well. So it's a combination of supply-side factors and demand-side factors that have pushed up inflation.
And then, further, the Russian invasion of Ukraine has also contributed to high inflation in the United States. So the blue line is the producer price index for intermediate, unprocessed goods. These are raw materials that businesses sell to other businesses, so things like crude oil, iron ore, raw timber, that kind of thing. You can see that that was very elevated in 2021, though we were starting to see a slowing there. But then, inflation at that level picked back up again with the Russian invasion of Ukraine, although it has started to slow barely over the last couple of months. We did experience a similar period of elevated wholesale inflation coming out of the last recession back in 2010, 2011, although not quite as severe.
If we look at the orange line, that is the producer price index for processed goods, for intermediate demand. These are finished goods that businesses sell to other businesses. So these are things like finished steel, machinery, IT equipment, that type of thing. And you can see, again, we have had a period of elevated inflation at that level although it has started to slow over the past six months or so. And then we did experience a similar period of elevated wholesale inflation coming out of the last recession, although again, it wasn't nearly as severe as it is this time around.
The green line is the inflation measure that the Federal Reserve is most focused on. This is the Core Personal Consumption Expenditures price index. So these are the everyday goods and services that we buy as consumers. Don't forget, we buy a lot of services as consumers, not just goods. So, we buy education, we buy healthcare, we buy financial services, we buy childcare services, those types of things. And this excludes food and energy prices because those can vary wildly and can obscure the trends in underlying inflation.
Now, according to the green line, the Core PCE price index, which is the Federal Reserve's preferred inflation measure, inflation is well above the 2% objective that the Fed has set. So the Fed wants to bring inflation down, although inflation is not nearly as high at the consumer level as it is at the wholesale level. But still, very high and much higher than what the Federal Reserve would like.
And a large part of the inflation that we have seen over the past couple of years has come from problems in supply chains. So this is the New York Fed's Global Supply Chain Pressure index. This is based on things like shipping costs, both in the United States and abroad; surveys of purchasing managers to indicate how quickly they can get the inputs that they need, and so forth. The long-run average for this is set to zero, and you can see that we are well above that long-run average. So there are still significant supply chain pressures in the US and global economies, but they are easy. You can see that they increased again in early 2022 with the Russian invasion of Ukraine, but have fallen since then. And I do expect that we will see global supply chain pressures to continue to decline in the second half of 2022 and return to more normal levels in 2023 as businesses increase output, as high costs discourage some economic activity and so forth. But I do expect that we will see a continued slowing in global supply chain pressures over the next year, year-and-a-half or so, and that will help bring down some inflationary pressures in the US economy.
Also, we see the Federal Reserve starting to reduce the size of its balance sheet. That is one of the factors that is putting upward pressure on long-term interest rates. So if you remember, at the beginning, I said the Fed was buying more long-term Treasuries, the orange bars. The Fed was buying more mortgage-backed securities, the blue bars. Those purchases in 2020, 2021, pushed down long-term interest rates but earlier this year, the Fed stopped making those purchases. And then more recently, the Fed has been letting those securities mature and has not been rolling them over. And so, that has been putting upward pressure on long-term interest rates in the US economy. That's why that 10-year Treasury yield has moved to around 3% or so. And we will see the Fed's balance sheet actually shrink in 2022 and 2023, so we do expect the long-term interest rates will remain elevated.
Those higher borrowing costs make it more expensive for businesses to borrow, for consumers to borrow, for home buyers to borrow. And that is slowing economic activity.
So, for example, we can see a substantial slowing in the housing market as mortgage rates have moved higher. So the blue line on the left-hand scale is your typical 30-year fixed-rate mortgage interest rate. You can see that that was below 3% in late 2020, early 2021. Remember, the Fed was buying mortgage-backed securities to push down mortgage rates. But as the economy is improved, as the Fed has stopped those purchases and is now letting those maturities -- those securities roll off its balance sheet, you can see that that 30-year fixed mortgage rate has gotten around, up to around 5.5%, 6% or so.
And with that, we have seen a big drop in existing home sales. So the orange line on the right-hand scale, that is the sales of existing single-family homes. You can see that they've fallen from, you know, close to $6 billion in the early stages of the pandemic to below $5 billion as housing affordability has increased due to both higher mortgage rates and higher home prices. And I would expect that we'll see similar declines in things like housing starts and so forth. And that is weighing on economic activity. That is slowing economic growth in 2022. That's a deliberate effort on the part of the Fed to increase borrowing costs and slow economic activity in an effort to bring down inflation. And financial markets do think that inflation will slow.
So this is not actual inflation. This is what financial markets think inflation will be 5 to 10 years in the future. So, between mid-2027 and mid-2032. This is based on the difference in yield between the regular Treasuries and then what we call TIPS, Treasury Inflation-Protected Securities. Those are Treasuries that pay a rate of return plus whatever inflation turns out to be in the future.
So you can see that financial markets think that inflation will be just about 2%, average just about 2% over the long run, right around the Federal Reserve's target. So financial markets do not think that the Fed will let that inflation persist in its current high levels. They are pretty convinced that the Fed will do what is necessary to bring inflation down over the longer run.
Now, another factor that is going to weigh on US economic growth and help slow US inflation will be a weaker global economy, in particular in Europe. The Euro Zone is heavily exposed to imported energy. You can see that about 60% of Euro Zone energy comes from abroad. Not all of that is from Russia, but a large portion of that is from Russia. And so, the Russian invasion of Ukraine has had a significant impact on the Euro Zone in particular. I would put the probability of recession in the Euro Zone over the next year or so at above 50%. They are dealing with high inflation; they are dealing with energy shortages. And so, that will be a significant drag on Euro Zone growth and overall economic growth, global economic growth. So you can see that the Euro area makes up about 15% of the global economy. The UK is an additional 3%. Their economy is also soft. And so that is going to be a significant drag on US exports, US economic growth over the next couple of years; and that is another factor that will bring down US inflation is slower global economic growth.
So the key question now is, we do expect that inflation is going to slow. But to bring inflation back down to 2% is the US economy going to fall into recession? Is the Fed going to raise interest rates so much that the US economy falls into recession? And what we're watching in particular is what we call the yield curve -- the difference in interest rates between short-term interest rates and long-term interest rates.
So let's look at the blue line. That is the difference in interest rates between the yield on a 10-year Treasury note, what it costs the Federal Government to borrow for 10 years, and a 3-month Treasury bill, what it costs the Federal government to borrow for 3 months. And you can see that the blue line is usually above the axis. Usually, it costs more money to borrow -- to the Federal government to borrow for a long period of time than for a short period of time, and that makes sense. Because when you lend for a short period of time, you're taking on less risk. And so borrowers -- lenders, excuse me -- don't demand as high an interest rate.
Now, you can see first of all, that whenever we see short-term interest rates move above long-term interest rates, then that blue line is below the axis, almost always, we get a recession. Those gray bars are recessions in the US economy. So when we see short-term interest rates move above long-term interest rates, we almost always get a recession.
Now you can see, if we look at the blue line, hey, we're in good shape. Long-term interest rates are up here. Short-term interest rates are down here. So we're not anywhere close to seeing that inversion. But on the other hand, look at the orange line. That's a difference between the 10-year Treasury note and the 2-year Treasury note, so that's kind of a medium-term interest rate. And you can see, that isn't as quite a good a predictor of recessions. But certainly, it is a good predictor of recessions, and you can see that that's just barely above the axis. That 10-year Treasury note rate is right around that 10-year Treasury note rate.
And so certainly, that does indicate that perhaps recession risks are elevated in the US economy. So, as of the summer of 2022, PNC does not expect the US economy to fall into recession over the next couple of years. But I think it is fair to say that recession risks are elevated.
So this is our baseline economic forecast. This is our most likely economic forecast over the next couple of years. And you can see that we have economic growth, the blue line, the dotted line is the forecast. We do expect that to slow over the next couple of years, but we don't expect to see an outright contraction in the US economy. We don't expect to see a recession.
The orange line is the unemployment rate. That was 3.5% before the pandemic, jumped up to almost 15% in the spring of 2020 as a recession came to the United States, the pandemic came to the United States. It's back down to 3.6% in mid-2022, basically back to its pre-pandemic level, the lowest unemployment rate that we've seen in about 50 years. But we do expect that with a bit weaker economic growth in 2023, 2024, that we will see the unemployment rate move up above 4% over the next year and a half or so. That will allow for a little more slack in the labor market, reduce some of those pressures that we are experiencing in the labor market. But our forecast now is not for recession.
Our most likely outcome is that the US economy avoids a recession. But we will see different sectors responding differently to what the Fed is doing then to slow our economic growth. So the dotted lines are the forecast. These are various measures of economic activity. I set the peak before the pandemic equal to 100. So, for example, we expect to see the real GDP will grow modestly over the next couple of years.
Real, fixed business investment, the black line, that is actually going to lead economic growth. Businesses will be investing to get more out of their existing workers with a very tight labor market that we're experiencing. Employment, the green line, on the other hand, is going to lag. As I mentioned, that is not quite back to its pre-pandemic level but should be there later this year. Industrial production, output of manufacturers, mines, utilities, that's going to grow at a moderate pace over the next couple of years.
On the other hand, look at housing starts, the red line. We expect to -- we started to see a slowing in the housing market. I expect that homebuilding will slow significantly over the next couple of years as the housing market adjusts to the higher interest rates, the higher mortgage rates in particular, that we've seen. And so that overall, the housing sector will be a drag on economic growth in the second half of 2022, and then in 2023, into 2024.
There's a lot of uncertainty out there in the US economy, but here's what I'm pretty certain. We did experience a very steep recession in 2020 and we will have continued recovery this year. The economy will continue to grow. We still have solid job growth; we still have consumers increasing their spending; we still have that extra savings that consumers have built up, and so that we will see continued improvement in the US economy in the second half of this year. The Fed will do what's necessary to bring inflation back down to 2%. We may not like how we get there, but that we will see inflation slow to 2%. We're not going to get there in 2022; we're not going to get there in 2023; but I would expect by mid-2024, inflation will be back to that 2% level that the Fed is shooting for, and that we will continue to see structural shifts in the economy due to the pandemic, the recession, and the ongoing recovery.
So for example, we've seen movement away from traditional retailing towards online sales. That process intensified with the pandemic and is going to remain in place. We're seeing businesses rethink their supply chain, shortening their supply chain, sourcing more from the United States or within North America, keeping more inventory on hand. And finally, we're seeing changes in commercial real estate markets, so less demand for office space because of work-from-home, more demand for warehousing space with the increased prevalence of online sales. Perhaps less demand for retail space over the longer run, as sales continue to move online.
But there's still a great deal of uncertainty out there. What happens with the Russian invasion of Ukraine? If it ends in the next couple of months, that would be a big boost to the global economy. That would help bring down inflation more quickly. Maybe the Fed doesn't need to raise interest rates as much.
Perhaps the Fed makes a mistake. Perhaps they overtighten. That's oftentimes what causes recessions in the United States is the Fed raising interest rates too much, or maybe the Fed sees no other way to bring inflation back down to 2%, but to increase interest rates and cause what would hopefully be a small recession. I put the probability of recession over the next year or two at about 40%, 45%. That's about double what it was prior to the Russian invasion of Ukraine, because either the Fed makes a mistake or they don't see any other way to get out of the current high inflation without a recession.
Hopefully -- and again, it's our baseline forecast that we don't have recession. But if we did get a recession, hopefully it would be mild. We don't have a lot of imbalances in the economy now that we had in let's say, 2006, 2007, and so forth. But the potential for recession is out there.
What happens with the pandemic? We seem to forget about that, but that's still out there. There's potential for further mutations of the virus that could make the pandemic much worse, could lead to renewed business shutdowns. What's the impact on longer-run growth of all the economic turmoil that we've experienced over the past couple of years? I'm hopeful that the pandemic hasn't damaged long-run growth in the United States economy. But that potential is out there. And then finally, we've seen big changes in the housing markets. People moved from apartments to single-family homes; we've seen people move out of the city into the suburbs or into rural areas. With the increasing prevalence of work-from-home, we've seen people move from more expensive markets to less expensive markets. Do we think that those changes are going to persist over the longer run? Or if the pandemic recedes, if we avoid a recession, are people going to move back to cities? Are they to move back to working in the office, and that that would keep people in big metropolitan areas? We'll have to see how that plays out. We won't have answers to these questions for a few more years.
Let's take a quick look at regional economic conditions. So this is the Philadelphia Fed's Coincident Economic Index. And so you go back before the -- right before the pandemic, February of 2020, the US economy was in solid shape. We were seeing economic growth throughout most of the United States, and really, the pandemic kind of came out of the blue and caused a very severe downturn, at a time when the economic fundamentals look pretty good. You go forward to May of 2020, conditions were not good at all. You can see that we experienced significant economic downturn in all parts of the United States. That's different from most recessions in the US, where usually there's one or two pockets of the country that are doing well. Not the case this time around.
You go through the most recent Coincident Index from May of this year, and you can see that, you know, all parts of the US economy are growing. Some are growing more strongly than others, but most states are in the strongest economic growth category. And so conditions look pretty solid. And again, this is why I don't think that we are in recession in mid-2022, and why I don't think we're likely to get a recession, you know, the rest of this year, is that in the middle of the year everything looks pretty solid in most parts of the country. We're seeing job growth. We're seeing consumer spending growth. And that would indicate that the economy will continue to expand at least in the near term.
I would encourage you to find all of our materials at PNC.com/economicreports. We put write-ups on the US economy, on the global economy, and I would encourage you to take a look at our materials there. You can follow me on Twitter @GusFaucherPNC. Thank you very much for your time.
And with that, Ian, have we had any questions come in that I can answer?
Okay, great, Gus. Thank you so much. We have gotten a couple of questions into the Q&A box here. We'll start things off with the first one. What supply response are we seeing to higher energy prices?
We are seeing a big increase in domestic energy production in the United States economy. So with oil, the run-up in oil prices that we've seen with the recovery, especially since the Russian invasion of Ukraine, we have seen much higher energy prices. Obviously, all of us are experiencing that. I mean, we've seen a big increase. So we see the oil and natural gas producers drilling more wells. Well drilling is up about 50% over the past year or so, and would be even stronger except that there are shortages of labor, there are shortages of materials. So we're seeing -- we are seeing a supply response and that's one of the factors that's helped push down energy prices more recently in the United States.
Gasoline prices haven't fallen as quickly, in part because there's a shortage of refinery capacity in the US. We haven't built a new refinery in decades in the United States, so even though we're producing more oil, it's more difficult to produce more gasoline. And so we have seen some increases in gas production, but it's less so compared to oil production. And that's why gasoline prices haven't fallen as much as oil prices over the past month or so.
All right. Fantastic. Our next question, what is the outlook for commercial real estate markets?
The outlook for commercial real estate markets, I think, is mixed over the next couple of years. First, let me say that when the pandemic hit, when we saw people working from home, we expected to see a decline in commercial real estate prices. And that has not happened. Commercial real estate values have held up quite well across all property types. More recently, I think, we are starting to see a divergence, so demand for industrial manufacturing space is very strong. Remember, we're seeing very high shipments, production of goods, and so we've seen solid gains in prices for industrial properties. Hotel properties, there was some concern about those, but now that travel appears to be rebounding -- both personal travel and business travel -- we're starting to see some indications that hotel prices are holding up and in fact, are expected to increase over the next couple of years.
I think we will see some softness in office prices, in retail real estate prices, over the next couple of years. Businesses have held on to their office space, but as leases come up for renewal I think we will see businesses leasing less space. We just have fewer people working from the office. We're going to have more flexible work arrangements where people may come in one or two days a week, and so we won't need as much office space. So I would expect to see office real estate prices decline over the next few years as that market shakes out.
Similarly, with retail estate prices, as I mentioned, we're seeing much higher online sales, less demand for traditional retail, brick-and-mortar sales. And so I would expect that we will see prices for retail real estate fall over the next few years as we continue to see the shake-out in that market.
All right. We can get another question in. What is the outlook for credit quality?
Credit quality has held up remarkably well in the United States, both business credit quality and consumer credit quality. As I mentioned, a large part of it is the aid from the Federal government, so we had aid to households that allowed them to pay their bills. We also had rent moratoriums, we had student loan moratoriums, and so forth. So, credit quality -- consumer credit quality -- is extremely good right now, and I expect it is going to weaken somewhat. We are going to see some of those moratoriums expire. We have -- we are starting to see households take on a big more debt. We are starting to see interest rates increase. We will see a slight softening in the labor market. So I do expect that we will see a slight deterioration in consumer credit quality over the next couple of years, but it's still going to be very good. And I don't see any big problems there.
Similarly, on the commercial side, commercial debt burdens are very low right now. Businesses used the PPP funding to repay their debt; they've refinanced their debt. If we look at business debt as a share of cash flow, that's near a record low. Now, businesses are exposed to rising interest rates. But generally, they're starting from a position of strength. Profitability is still pretty good there. And so I would expect that although we will see somewhat of a deterioration in commercial credit quality, I think that that's going to hold up pretty well. And I would also point out that lenders generally have been very good with making sure that they aren't lending to bad credit risks.
So if we look at subprime loans, for example, those as a share of total originations, are much lower now than they were before the great recession, back in 2005, 2006. Businesses, banks, have been -- and let me make it clear that I'm referring to banks in general, not to PNC in particular -- but lending standards have been very solid. And so I don't see the excesses in lending this time around that we had before the previous recession 15 years ago, before the great recession.
All right. We do have time for one final question here. What is the long-term outlook for international trade?
You know, we have seen -- and this predates the pandemic -- we have seen countries turn more inwards over the last 10, 15 years or so. I think it was exacerbated by the great recession back in 2007, 2008, but even started before then. We've seen that in the United States with the Trump administration, but also the Biden administration keeping tariffs on Chinese-made goods. We saw that with the renegotiation of NAFTA, now the US and Mexico, Canada Agreement, USMCA. We've seen that in the UK with Brexit; we've seen China turn more inward. So I think that this is a global issue. I do think that countries -- and I think it's probably been exacerbated by the pandemic and it's also been exacerbated by the Russian invasion of Ukraine, with many countries imposing significant sanctions on Russia. And so I think that businesses in the United States have recognized that there are problems having these long supply chains that extend all the way to Asia. We've had big problems with shutdowns in China that has made it difficult to get some products into the United States. We've seen transportation difficulties and so forth. And so, I think that perhaps we're going to see trade flows retreat somewhat over the next decade or so.
I still think that there are big advantages to international trade, that it allows specialization in different countries. Certainly I think that overall, trade has supported higher standards of living in the United States, although it certainly has hurt some types of workers, particularly workers who were in perhaps industries required lower formal education, that -- manufacturing, and so forth.
So you know what, I think we're in a period where perhaps global trade flows may not return to where they were before the pandemic for 10 years, 20 years, something like that.
Okay. That is all we have time for with questions. So, Gus, I'd like to thank you so much for your presentation here. And we'll go ahead and wrap things up.
As a reminder, as it says here on the screen, you can visit PNC.com/economicreports for more information. And information on a replay will be sent to you after the event's conclusion. Thank you all for joining us today, and have a great rest of your day.