By ITR Economics

ITR Economics recently revised its outlook for the US industrial sector. We covered the driving factors in the revision itself and the factors that will keep the upcoming recession “mild”—or more akin to the recessions in the early-1990s and early-2000s than the Great Recession of 2008. Below, we expand on those positive factors.

• For consumers: record consumer spending, robust real income, low credit burdens

Consumer spending, as measured by the US Total Personal Consumption Expenditures and adjusted for inflation, is at record highs. At the same time, Real Personal Income (excluding transfer receipts) is hovering around record highs. We track income “excluding transfer receipts” to adjust for the massive amounts of government stimulus money that was disbursed during the pandemic. The Expenditures and Income figures alone suggest that consumers are broadly on solid financial footing and will be able to weather higher interest rates and hawkish Federal Reserve policies relatively well. In addition, consumers generally have exceptional room to borrow. Household credit card debt as a percentage of median annual earnings averaged just under 13% in the third quarter of 2022 (latest available data). The pre-pandemic, five-year average was roughly 14.7%, and, leading up to the Great Recession, credit card debt rose above 20% of median annual earnings. The current low levels of credit card debt burden suggest consumers have some cushion to borrow before their finances become shaky. It is important to note, however, that lower- and fixed-income consumers are likely to be hit harder by the recession, because they have already been squeezed by inflation. Higher-income consumers and those in lower cost-of-living areas are likely to fare better, relatively, throughout this time.

• For businesses: record profits, robust backlogs, and reshoring trends

US Corporate Profits for the third quarter of 2022 (latest available data) were virtually even with the record-setting second quarter, indicating relative success at navigating elevated inflation, supply chain snags, and waning cyclical momentum both at home and abroad. During the pandemic, supply chains became so tangled that even now the Global Supply Chain Pressure Index is elevated relative to normal levels. Many businesses were unable to fill orders amid stimulus-fueled record demand, leading to elevated backlogs. Lead times remain elevated in a variety of industries. This suggests that backlogs are likely to stay relatively robust, which will ease some of the impacts of the current higher interest rates and temper industrial sector decline. Finally, onshoring and reshoring trends—that are, in part, efforts to avoid future supply chain disruptions—are a positive trend for US businesses.

Given the consumer and business strengths laid out above, we expect the 2024 recession to be relatively mild compared to historical cycles; the expected decline in annual US Industrial Production, peak to trough, will come in at 2%–3%. However, there is risk that the Federal Reserve Board will keep interest rates elevated longer than anticipated, given the body’s recent hawkish rhetoric. If the yield curve remains inverted beyond 2023, it would indicate a risk to the anticipated timing and amplitude of the upcoming recession in the industrial sector. We will be watching the above factors closely to determine if new risks are developing. For example, while backlogs are elevated, order cancellations are more likely on the back side of the business cycle.