AM Best: bumpy road for US economy's soft landing
A new AM Best report has good news for those observing the “better-than-predicted” US economy and its importance to Bermuda’s future.
The report said recent economic performance had significantly reduced the possibility of a recession in 2024, but would not stop the slowdown in growth.
Ann Modica, director, AM Best, noted that gross domestic product growth was above trend and ended up at 2.5 per cent for the year.
She said growth was mainly driven by domestic consumption, which accounted for about 70 per cent of total GDP, and consumers continued to be supported by a strong labour market.
She said: “Real wages turned positive in the second half of the year as inflation continued to moderate. There was a positive wealth effect with the rise in the stock and housing markets. Government spending was also a positive driver.
“But somewhat more interesting, I think, is it also appears that the transmission mechanism of monetary policy has been weaker than it had been in previous cycles, with households and businesses appearing to be somewhat less interest rate sensitive to the Fed rate hikes.
“Both took advantage of the previous cycle low-rate environment. A majority of consumer debt is fixed and businesses have pushed out the duration of debt maturities alleviating some of the immediate pressures from higher rates.”
Ms Modica said: “One category of inflation that is expected to come down this year is shelter inflation, which is huge because it's the largest weighting in the CPI index at almost 40 per cent.
Shelter inflation ended the year at 6.2 per cent, which is a year-over-year growth which is more than double it's historical average. It kind of sounds like bad news, but it started to come down from its peak in May of 8 per cent and I would expect that this would come down further because shelter is a lagging indicator.
“Leases renew typically on an annual basis, so it does take some time for those price changes to cycle through.”
The downside risks include global conflict, supply chain disruptions and commodity price shocks.
Ms Modica said that higher mortgage rates and the elevated home prices continued to negatively impact the housing market. Sales hit a nearly three decade low last year.
While housing prices only increased moderately in 2023, prior appreciation kept home prices really high.
The Home Affordability Index is close to an all-time low. The index tracks home affordability on three metrics, sale prices, mortgage rates and income.
Ms Modica said: “While the appreciation in prices and high rates has played a large part in the lack of affordability, so has a lack of inventory. While the lack of housing inventory is not a new problem, it has been exacerbated by the large differential in mortgage rates pre and post-pandemic.
“Most current homeowners are rate locked. With mortgage rates much lower than the current prevailing rate and this is creating a huge disincentive for homeowners to move from their current home if they need to finance for a new home at a higher rate.”
Ms Modica predicts a 2024 slowdown in consumer spending and slowing economic activity, with a low risk of recession.
“Labour markets are expected to moderate,” she said. “Unemployment might tick up slightly but this is from a historically low base. We have seen some negative factors with regards to higher revolving credit lines, lower savings rates, and delinquencies are starting to tick up, and this is particularly true for younger and lower income households.
“I also think there's going to be more economic uncertainty with regards to the upcoming elections in November. We also have an elevated degree of worldwide geopolitical tensions around the world that could also cloud economic outlook for both growth and inflation.
“And of course, there's the Fed, right? All eyes are on them this year and what their plans are in reducing rates. The Fed did take a dovish tone in December, signalling they would cut rates by 75 basis points this year. Markets, at the same time, priced in double that amount of cuts. But so far the Fed has really stood their ground, signalling they are in no hurry to cut rates, and markets have slightly pulled back on their projections for the early timing and the extent of cuts.
“I do think some of the more recent positive economic data makes it less likely the Fed will cut in March but I guess time will tell. It should be an interesting year.”