ECONOMY & POLICY
January 08, 2024
Chief Economist Eugenio Alemán and Economist Giampiero Fuentes examine the factors which will contribute to the U.S. economy's path forward in 2024.
To read the full article, see the Investment Strategy Quarterly publication linked below.
Just as pilots assess conditions before landing, Fed Chair Jerome Powell analyzes the U.S. economy as we enter the final leg of the post-COVID-19 journey. Meanwhile, as investors fasten their seatbelts and hope for a soft landing, we economists fine tune our forecasts for the year. The economy is expected to fluctuate as we expect a wide range of headwinds and tailwinds to challenge the U.S. consumer, but despite some turbulence, we continue to believe that there will be a safe landing.
Inflation: We have started our descent
After more than a year when some analysts argued that structural changes were probably going to keep inflation higher than during the pre-COVID period while preventing the Fed from achieving its inflationary target, inflationary pressures continued to push lower during the third and fourth quarter of last year with no signs that structural changes would be able to prevent the Fed from achieving the 2% inflation target.
The Consumer Price Index (CPI) continued its disinflationary path toward the end of 2023, bringing significant optimism to investors. Hopes of a soft landing and expectations of inflation hitting the 2% target faster than many had expected have pushed markets to believe that the Fed will cut rates several times in 2024, starting in the first quarter. We disagree with the markets because we believe that the Fed is more concerned about a potential reacceleration of inflation, especially if the U.S. economy can avoid a recession and it will be very careful in moving rates lower.
If we assume the economy continues to be strong and experiences a soft landing, what would be the rationale for lower rates if the economy can handle a 5.5% federal funds rate and still grow unabated? In this case, we believe the Fed would be more mindful to preserve the opportunity to ease monetary policy if a future recession requires it. For example, along with quantitative easing, the reason the Fed was able to ease monetary policy in the wake of the COVID-19 pandemic was because it raised the fed funds rate from 0-0.25% in 2015 to 2.25-2.50% in 2019. On the other hand, if rates were already lower in 2020, the Fed would have had less ‘cushion’ to work with.
Even if the economy goes into a mild recession as we are still expecting, the Fed is going to be reluctant to move interest rates much lower fearing that lower interest rates could push inflation higher again.
National debt: Sustained crosswinds
The impact of interest rate increases, amounting to more than 500 basis points since the hiking cycle began, has adversely affected both consumers and the government. The government's annual interest expenditure on the public debt is projected to surpass $1 trillion in 2024, marking the highest figure on record. However, the challenge lies not in the ability of the U.S. to meet its debt obligations; rather, the biggest issue with the U.S. debt is that the political system needs to agree on an already stretched budget to include these interest payments, as well as a long-term solution to the debt problem.
Today, about two-thirds of government expenditures are earmarked for non-discretionary, or mandatory, programs. That is, unless there are changes to current laws, we need to keep paying those expenditures. This is something much like ‘fixed costs’ in terms of business parlance: there are no degrees of freedom to change those expenditures in the short-to-medium run unless there is agreement between the parties in Congress. The remaining one-third of government expenditures are discretionary, which the U.S. government could potentially adjust to allow for payment of higher interest payments on the debt, but these outlays also require political agreement to decide on a solution.
Labor market: Turbulence ahead
The U.S. labor market added over 2.5 million jobs in 2023, but nonfarm payrolls started to slow during the last few months of the year. Job openings have been on a downward trend since peaking in 2022 and we expect this trend to continue in the first quarter of 2024. As the economy continues to slow, we expect the labor market to contract slightly starting in the second quarter of this year. This should push the unemployment rate higher, to ~4.8% in the third quarter of 2024, but we expect the labor market to start to recover before the year ends.
The bottom line: Cleared for landing
Stable and lower inflation, lower job growth and a weaker consumer are going to slow economic growth from the strong expansion experienced in 2023 to ~1.0% in 2024. While we continue to expect a very mild recession that lasts for two quarters, we want to emphasize that the overall growth for the year will remain positive. With current available resources, the U.S. is estimated to be able to grow sustainably at ~1.9% without triggering higher prices. Therefore, our GDP forecast for the U.S. economy, if it materializes, should not only be welcomed by investors but also by the Fed as inflation will be less likely to reaccelerate.
The economic outlook for 2024 should not be the year of ‘recession’ but rather a year of ‘sustained disinflation with weak economic growth.’ In fact, according to our forecast, the upcoming recession would not only be very mild, with fewer job losses and declines in fixed investments, but also shorter in duration than the average recession. While we expect consumer spending to weaken, we expect government and nonresidential fixed investment to grow more and provide a cushion to the economic slowdown. The bottom line is that the US economy has been cleared for landing, but in our opinion, it is unlikely to be as soft as many are predicting.
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