Auto workers gearing up for a strike, a potential government shutdown, and student loan payments resuming are coinciding and could all spell trouble for the U.S. economy. EY Chief Economist Greg Daco joins Yahoo Finance to break down the overhang these headline events and recent inflation data can have on GDP growth and consumers.
When asked about the ongoing, and potential, strikes Daco explained: "There is a direct effect on employment. There is a direct effect on spending, and there is also a direct effect on the regions that are affected that are dominated by those sectors, in this case, the automotive sector in the midwest."
Video Transcript
JULIE HYMAN: GDP growth is facing a triple threat. At least, that's what our next guest is warning ahead of the Fed's meeting next week. Chair, Jay Powell, will have to weigh all of the latest inflation and labor data as usual. But Greg Daco suggests some wider political issues may have to be considered as well. Greg, it's great to see you.
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GREG DACO: Pleasure to be here.
JULIE HYMAN: Thanks for being here. So what are we talking about here when we're talking about this triple threat to GDP?
GREG DACO: Well, I think first of all, it's important to highlight that there's been a lot of optimism about the US economy. There's been a lot of optimism about the direction of inflation coming down lower. But there are a number of threats on the horizon. And we have to have a nuanced view.
We know that the resumption of the student loan payments is going to hit consumer spending. We also know that there is the risk of a strike from auto Union workers that could subtract about a tenth from GDP for every week of strike. And then we have the threat of a government shutdown as we go into October, which could also subtract about a tenth for every week of government shutdown. If you add all those factors up, it could add up to a significant drag on growth in the fourth quarter.
JULIE HYMAN: These are sort of, at least in two of the three, sort of known knowns. I mean, the case of student loan payments, we've been talking about this for months-- that this was going to happen, a government shutdown, Oh, it's like an annual occurrence at this point. The UAW is really, I would say, of those three, the biggest wild card.
So given that, there are two questions, right? There's the sort of economic question. Then there's the market question. The market seems to have decent visibility in, again, at least two of three of these cases. Is the UAW really the one where that has the most uncertainty, do you think?
GREG DACO: Yeah. I mean strikes are always uncertain phenomenons. And they can have visible impacts very quickly on economic activity. We saw it last month in the last payroll report where we had the strikes of the screen actor guilds weighing on employment gains. We're going to see it again if we see this strike last for a duration of time.
So yes, there is a direct effect on employment. There is a direct effect on spending. And there is also a direct effect on the regions that are affected, that are dominated by those sectors. In this case, the automotive sector in the Midwest.
So yes, there is a perceptible impact in terms of economic activity. There is also a potential impact in terms of inflation. Because we are and still remain in an environment that is undersupplied. So any further hits to supply, whether it's in the auto sector, the housing sector, will lead to renewed inflationary pressures, which is exactly the opposite of what we need today.
BRAD SMITH: And so you know, number one, love a good triple threat basketball reference to begin the morning. Secondly here, when we think about the data that's come out over the course of this week, retail sales data that the latest this morning as well, when you pass that through in a hotter than expected retail sales report to inflation, what's the correlation there from your perspective?
GREG DACO: Well, I think we have to be careful to stay on the sports analogies with using the old playbook when we analyze the data. We have to be very careful as we look at retail sales, knowing that these are nominal figures. They're not adjusted for inflation.
If you look at the figures adjusted for inflation today, they were actually coming down. Retail sales contracted once you adjust for the higher prices. Core retail sales, which takes out some of these volatile elements, was down 0.3% on the month. We're seeing, if we look at a year over year basis in terms of inflation adjusted retail sales, so volumes are down about 1 and 1/2 percent.
So yes, people are spending more dollars. But they're buying fewer items. And they're going out to dine less frequently than they were a year ago. There is an ongoing slowdown. No retrenchment in consumer spending activity. But a slowdown and more discretion when it comes to what people buy and how often they do.
JULIE HYMAN: And it was interesting earlier in the week to get data that incomes have continued to trend lower, right? That's sort of the backdrop. So put everything together for us, Greg. We're looking at these threats to GDP. There has been this narrative of a soft landing. Is that something we need to rethink to some degree?
GREG DACO: Well, I think we have to have nuance when we analyze the data. Yes, a soft landing is very possible. Yes, there is true underlying reasons to be optimistic about the economic outlook. The main reason is the resilience in the labor market.
But we also have to factor the headwinds. We talked about the triple threats. We also talk about the conditions on the credit front that are worsening.
We're seeing an environment where people are struggling when it comes to paying their debt. They're having higher interest payments. They're having higher debt burdens when it comes to paying car loans, auto loans, and general consumer loans. And that is weighing on their ability to spend on other items.
So I think we have to be conscious that this economy is not accelerating. It's decelerating. Fortunately for us, it's not retrenching. But we have a number of headwinds that are going to materialize over the coming months. And let's not forget, the Fed is still keen on maintaining a very restrictive monetary policy stance. So we won't get a helping hand from the Fed in this slowdown.
BRAD SMITH: What you just described doesn't sound like a household balance sheet among consumers that's healthy. And I guess, yeah, you can and be healthy and still have a slight bit of a cough or sneeze or if you get here before the AC comes on in our office. You might get a little bit of a throat tickle. All that considered, is this a consumer that is actually healthy or is or has a cold right now or has the sniffles?
GREG DACO: No. I don't think that's really the concerning part. The very encouraging part that we had when we entered this COVID crisis was that balance sheets were actually very healthy. The level of debt relative to income was at a 20-year low. We saw during the pandemic that there was a record rise in wealth, both on the real estate side and financial wealth. And we also had the excess savings that provided this buffer against higher inflation, higher interest rates.
Now, we're starting to see some of these elements start to turn. They're not unhealthy yet. But they're starting to be less healthy than they were two years ago, or three years ago. And that is something that we have to pay attention to. Because people prioritize-- if they have to pay certain elements, let's say student loans, or they have other headwinds in terms of less income growth, then they're going to be prioritizing their spending. And that will lead to slower spending across the board.
JULIE HYMAN: One final question on the ECB and the rate decision it made today to raise rates, sort of prioritizing that inflation fight over concerns over, maybe, a little bit of vulnerability on the economic front. Is the ECB then at more peril of tipping into worse economic situation as a result of that?
GREG DACO: I think overall, the fundamentals, when it comes to the economic situation in Europe are worse than what they are in the US. We are seeing that some of the major economies across Europe are slowing down sharply. Germany is probably already in recession. Unfortunately, Europe has to deal with this environment where inflation remains quite high and growth momentum is slowing faster. This is a stagflation type of very difficult situation to negotiate.
JULIE HYMAN: So was that the right decision today?
GREG DACO: I think in the context that we're in today, where we still have inflation across European economies that is very high, the ECB was right to implement that additional rate hike. That's not going to make or break an economy, that additional rate hike. But it will leave monetary policy on a more restrictive stance, which is what all central bankers are trying to do, including the Fed.
The Fed has the benefit that inflation has come down quite a bit. So real rates, rates adjusted for inflation, are actually quite high around one 1.5%. That is the restrictive stance that the Fed would like to maintain. And that's why we believe the Fed is done with its tightening cycle while it will still leave the window open to potentially further tightening, if necessary.
JULIE HYMAN: All right. We'll check back in with you as we get closer to November and see what happens. Greg Daco, EY Chief Economist.
GREG DACO: Thank you.
JULIE HYMAN: Thank you so much. Great to see you, as always.