State of the State Mid-Year 2023: U.S., Arkansas economies to be pressured but won’t falter

Editor’s note: The State of the State series provides reports twice a year on Arkansas’ key economic sectors. The series publishes stories to begin a year and stories in July/August to provide a broad mid-year update on the state’s economy. Link here for the State of the State page and previous stories.

Just a few months ago, it was considered a surprise if the U.S. economy did not enter into a recession, even if shallow. The more widely held belief now is similar to that of economist John Shelnutt who says the U.S. economy shows “no sign of faltering.”

Shelnutt, director of economic analysis and tax research at the Arkansas Department of Finance and Administration, told Talk Business & Politics that real U.S. GDP growth will remain resilient even “under the accumulated weight of interest rate hikes by the Federal Reserve.”

Goldman Sachs on July 19 lowered its closely watched recession odds from 25% to 20% but said economic growth may slow in the near term.

“Growth is expected to decelerate somewhat in the coming quarters, mostly because of slower growth in disposable income (especially when adjusted for the resumption of student debt payments) and a drag from reduced bank lending,” noted Jan Hatzius, chief economist and head of Goldman Sachs Research.

That sentiment is shared by Dr. Michael Pakko, chief economist and state economic forecaster at the University of Arkansas at Little Rock’s Institute for Economic Advancement.

“The expectations for a nationwide recession have lessened considerably over the first half of 2023. At the outset of the year, a short, shallow recession was expected to take hold sometime in 2023. The probability of that recession now appears negligible,” Pakko noted. “I still expect that the Federal Reserve’s interest rate hikes will continue to dampen growth, but not so severely as to result in a contraction.”

BY THE NUMBERS
Key measurements continue to paint the picture of a stable, if not healthy, U.S. economy. The national jobless rate in July – the most recent available – was 3.5%, down from 3.6% in June and unchanged compared with July 2023. The national Gross Domestic Product (GDP) grew 2% in the first quarter and was up 2.4% in the second quarter, according to the initial estimate from the U.S. Bureau of Economic Analysis.

“The increase in the second quarter primarily reflected increases in consumer spending and business investment that were partly offset by a decrease in exports,” the BEA noted in its report.

The actual average hourly earnings for all U.S. workers was up 1.1% in July compared with July 2022 and up 0.3% compared with June 2023. Inflation, which has been higher than historical norms, is moderating and was up 3.2% in July compared with July 2022. According to the U.S. Bureau of Labor Statistics, 90% of the 3.2% rise was tied to higher rents and mortgages. The July inflation rate was below the 40-year high of 9% in June 2022.

However, consumer spending, which is given much of the credit for a resilient U.S. economy, is under pressure. According to the closely watched Quarterly Report on Household Debt and Credit from the Federal Reserve Bank of New York, total household debt rose by $16 billion to $17.06 trillion in the second quarter of 2023. More importantly, credit card balances reached a new high of $1.03 trillion.

“Other balances, which include retail credit cards and other consumer loans, and auto loans increased by $15 billion and $20 billion, respectively. Student loan balances fell by $35 billion to reach $1.57 trillion, while mortgage balances were largely unchanged at $12.01 trillion,” noted the Fed report.

OTHER GROWTH FACTORS, ARKANSAS EXPECTATIONS
But Shelnutt says the economy will continue to grow through a resurgent housing sector. He said “housing shortages from the prior pandemic era and supply chain issues” combined with robust employment will result in growth in that large part of the U.S. economy. He also cited a non-consumer factor behind his optimism.

“A second factor for ongoing growth amid rising interest rates is the prior recapitalization of many businesses with historically low rates in recent years. Thus, net corporate interest costs reached historically low levels recently among S&P 500 companies. Combined, these factors are likely to support growth for a longer period while slow progress is made on inflation fighting and overly tight labor market conditions,” he said.

Shelnutt does believe U.S. growth will slow, with fourth quarter GDP coming in at less than 1% growth because of the pressure of rising interest rates and “some moderation in consumer expenditures.” He said the U.S. economy will see a “shallow recovery” in much of 2024 “before average growth and contained inflation are realized in 2025.”

Pakko has a similar outlook for the Arkansas economy.

“The (Arkansas) unemployment rate is likely to inch higher by the end of the year but will remain below 3%. The outlook for the labor market is more uncertain looking ahead to 2024, where forecasts are now suggesting the national slowdown will be concentrated. Similarly, Arkansas’ Gross State Product growth is likely to slow toward the end of the year but is expected to expand at a rate of around 1% through 2024,” Pakko wrote in a note to Talk Business & Politics.

Arkansas’ construction industry will be an “ongoing source of growth,” according to Pakko, with recent record gains in health services and the tourism industry likely to moderate but still be strong. Shelnutt believes job growth will continue in Arkansas’ service sectors, including leisure and hospitality, healthcare, social assistance and educational services.

“The Arkansas service sectors should see continued growth in the second half of 2023 and the first half of 2024 given the likelihood of full employment conditions continuing and still confident consumers,” he noted.

The state’s most recent jobless report supports the optimism about Arkansas’ economy. A year-over-year gain of more than 21,000 jobs and an almost 20% drop in the number of unemployed pushed Arkansas’ June jobless rate to a new record low of 2.6%. June was the fourth consecutive month of record low jobless rates in Arkansas.