Augustine (Gus) Faucher is senior vice president and chief economist of The PNC Financial Services Group, serving as the principal spokesperson on all economic issues for PNC.
Prior to joining PNC as senior macroeconomist in December 2011, Faucher worked for 10 years at Moody’s Analytics (formerly Economy.com), where he was a director and senior economist. He was responsible for running the firm’s computer model of the U.S. economy, edited a monthly publication on the U.S. economic outlook, covered fiscal and monetary policy, and analyzed various regional economies. Previously, he worked for six years at the U.S. Treasury Department, and taught at the University of Illinois at Urbana-Champaign. He was named senior vice president in March 2015, deputy chief economist in February 2016, and to his current role in April 2017.
Faucher is frequently cited in international, national, and regional media outlets including The Wall Street Journal and The New York Times. He has appeared on ABC World News, CBS Evening News, NBC Nightly News and Nightly Business Report, and is regularly featured on CNBC, CNN and Fox Business. In addition, he appears regularly on CBS Radio, NPR and Marketplace.
Webcast Transcript:
Hi, I'm Gus Faucher, Chief Economist for the PNC Financial Services Group with the 3rd Quarter Economic Outlook. Interest rates continue to increase in the United States as a Federal Reserve has tightened monetary policy over the past couple of years in response to high inflation. Both short-term and long-term interest rates have been going up and we continue to see the Federal Reserve raise the Fed Fund Rate, their key short-term interest rate, in response to higher inflation.
This in turn has contributed to problems in the financial system, including a few highly publicized bank failures. However, the problems do appear to be confined to a few banks that have particular problems. Overall, the banking system as a whole is well capitalized. If we look at bank capital relative to assets, that is very good right now, is much higher than it was before the Great Recession in 2007 and 2008.
In fact, it's up slightly from before the pandemic, so banks do have a lot of capital on hand to address any particular issues. And the problems at the banks were isolated to those that had specific problems. So for example, both Silicon Valley Bank and First Republic Bank, which failed, had high shares of uninsured deposits. That is deposits above the FDIC's $250,000 insurance limit, and that contributed to their problems.
In addition, we saw the FDIC and the Federal Reserve step in aggressively to shore up the banking system following these problems. And the banking system as a whole is still doing quite well and most banks are quite safe. We continue to see economic expansion through the middle of 2023. In particular, real GDP output of goods and services, which fell about 10% during the pandemic, is now about 5% higher than it was before the pandemic, and in fact, has returned to its long run trend.
That being said, we are seeing big shifts in activity in the economy. These numbers, I set the peak in 2019, Q4 equal to 100, and they are adjusted for inflation. Consumer spending on goods is about 15% higher than it was before the pandemic. On the other hand, if we look at consumer spending on services, that's only up the few percent from before the pandemic.
Similarly, business investment has seen modest growth since the pandemic. And then housing, which boomed with the pandemic and very low mortgage rates, is now about 10% below Its pre-pandemic level of activity. And this is all being driven by trends in what we call after tax personal income. Again, this is adjusted for inflation.
You can see those big spikes there in early (inaudible), 2020, and early 2021. And then they fell after the expiration of stimulus payments, but they are growing again due to job growth and wage gains. But we are seeing modest growth in consumer income, and that will be a drag on consumer spending going forward.
We have some good news and some bad news on the inflation front. This is the New York Fed's global supply chain pressure index with the long run value equal to zero. This is based on things like shipping costs, shipping time, surveys of purchasing managers and so forth. And you can see that we had big problems in the global supply chain with the pandemic and the very strong economic recovery.
But more recently we've seen supply chain pressures fade, and in fact, now they are below their long run average. And that's good news on the inflation front. But we still have some problems with inflation in the US economy. This chart shows various types of inflation on a year over year basis.
Energy inflation, the green line, was very strong following the Russian invasion of Ukraine, but is now down on a year over year basis. On the other hand, if we look at food and beverage inflation, the black line, that was very strong in 2022, but has been slowing more recently as we soon food prices stabilize.
Core goods inflation, that is goods excluding food and energy goods, is actually quite low right now after this easing in supply chains. But what the Federal Reserve is most concerned about is the blue line, core services inflation. This is inflation for services, excluding food and energy, and you can see that that picked up in 2021 and remains elevated.
This is worrisome for the Federal Reserve for two reasons. First, this inflation tends to be sticky from month to month. It tends to be persistent, and so it can lead to persistently high inflation. Also, a lot of this is driven by wages, and so a tight labor market will drive up wage growth and drive up core services inflation, and so the Federal Reserve is trying to push against that by raising interest rates in an effort to cool off economic growth in the labor market, and reduce wage pressures in the US economy.
The result is likely to be a US recession [00:05:00] starting later this year as we feel the full impact of those higher interest rates on the US economy. But the recession should be mild for a few reasons. One of which is, as I discussed earlier, that the banking system is in good shape. Another reason is, is that the labor market is very tight and businesses will be reluctant to lay workers off.
The labor force participation rate, the share of adults who are either working or looking for work, is now structurally lower than it was before the pandemic, and that is keeping the labor market tight, and that will deter businesses from laying off workers, even if we do see a slowdown in the economy, because they'll be concerned about finding workers once the economy starts to pick back up again.
Another reason the recession will be mild is because the housing market has been undersupplied for years. Housing starts are much, much lower than they were in the late 1990s and early 2000s. And in fact, the problem in the housing market is as we don't have enough homes out there, and that will prevent a collapse in home prices and a collapse in home sales and support a mild recession.
PNC's baseline economic outlook is for a modest contraction in real GDP starting in the second half of 2023. And then we expect to see economic growth resume in the first half of 2024 as the Federal Reserve starts to cut interest rates in response to a deteriorating labor market and slowing inflation.
The unemployment rate, which is at around 3.4%, the lowest rate we've seen in more than 50 years is expected to increase gradually over the next couple of years, peaking at above 5% in late 2024 before starting to decline with a slower labor market. Thank you very much for your time. You can find all of our materials at pnc.com/economicreports, and you can follow me at on Twitter @gusfaucherpnc.
