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North America Macroeconomic Update: Resilient Economies Call For Tighter Monetary Policy

DBRS Morningstar released its semiannual North America Macroeconomic Update. The U.S. and Canadian economies continue to show remarkable resilience in spite of tighter monetary policy. Households are spending at a robust pace, supported by healthy balance sheets and tight labor markets. The inflation outlook is clearly improving, but returning to the two percent target could still be challenging. The Federal Reserve and the Bank of Canada are responding to resilient economies with higher rates for longer.

Key highlights:

-- Consumers continue to spend at a robust pace, but tighter financing conditions are dampening activity in rate-sensitive sectors, including business investment, residential investment and durable goods.

-- The inflation outlook has improved over the last six months, but services inflation could still prove to be somewhat sticky and complicate efforts to reach the 2% target. Given that services are labor intensive, bringing inflation durably down to the target will likely require greater slack in the labor market.

-- Stronger than expected domestic demand, tight labor markets, and ongoing price pressures have led the Federal Reserve and Bank of Canada to continue tightening monetary policy. Recent statements point to policy rates being higher for longer relative to expectations just a few months ago.

“We expect the U.S. and Canadian economies to slow close to stall speed in the second half of 2023 as the lagged effects of monetary tightening are fully transmitted to the economy,” says Michael Heydt, Senior Vice President, Global Sovereign Ratings. “This implies a cooldown in consumer spending, a deeper downturn in rate-sensitive sectors, or some combination of the two.”