The US economy is about to hit a slowdown as Americans blow through savings, shrink investments, and battle higher interest rates, chief economist says

• The economy is set to enter a recession the next quarter, according to Pantheon's Ian Shepherdson.
• That's due to shrinking savings & investment weighing on GDP growth, the chief economist said.
• He forecasted GDP would shrink by 2% in the next quarter, starting a slowdown that would last through fall.

The US economy will slow as Americans blow through their savings and shrink investments while battling tighter financial conditions, according to Pantheon Macroeconomics' chief economist Ian Shepherdson.

Shepherdson previously estimated that GDP in the US grew 1.4% year-over-year over the past quarter, not far from the 1.1% GDP growth the Commerce Department reported on Thursday morning. While that suggests the economy has continued to expand amid high inflation and tighter financial conditions, that growth rate isn't sustainable, Shepherdson warned, predicting the economy would enter a slowdown over the second quarter and cause GDP to shrink by 2%.

"It would be dangerous … to extrapolate that apparent strength in the first quarter into an expectation of a decent spring and summer," Shepherd said in a note on Thursday, adding that key areas of the economy were already starting to slump.

For one, although consumer spending has been buffered by a large stash of household savings built up since the pandemic, Americans have already blown through over $1 trillion of that amount, Shepherdson estimated. That means the buffer of extra cash cushioning the economy is now less than half of what it was at its peak. 

That's expected to throttle economic growth, as well as shrink amount of investment in the economy. Shepherdson estimated the US suffered a 6% year-per-year drop in real housing investment over the past quarter, with a 23% investment drop over the past three quarters. Meanwhile, core capital goods orders posted a 0.4% drop in March, which suggests that the business investment portion of GDP will soon fall as well.

The fall in business investment is largely due to the Fed's aggressive rate hikes over the past year, Shepherdson said, with central bankers having raised rates aggressively to tame inflation. While markets are expecting the Fed to cut rates later this year, forced rate cuts in the fall could take until 2024 before leading to a meaningful recovery in business investment spending, Shepherdson said, suggesting Americans would have to deal with a sluggish economy for the time being.

"In short, then, we think the first quarter's decent-looking increase in GDP will be followed by a modest outright decline in the second quarter, marking the start of a recession which we expect to last until the fall," Shepherdson said. 

His view echoes that of other market commentators, who say a recession is highly likely this year as inflation remains well-above the Fed's 2% target and financial conditions tighten. The Fed is now forecasting a mild recession to strike later in 2023, and the economy could take until 2025 to fully recover, the central bank's economists said previously.