Economic outlook for the US - Q3 2024

US growth is forecast to continue to slow this year, accompanied by a deterioration in the labour market, lower wages growth, softening inflation and weakening consumer demand. While there is no threat of a recession, the culmination of these factors will allow the Fed to deliver a first interest rate cut this autumn. But with a real rate of interest already in heavily restrictive territory, this first cut will be followed by a quick succession of further cuts as the Fed moves to ensure its goal of a ‘soft-landing’ is achieved.

Growth set to slow in 2024, but Fed to achieve its goal of a ‘soft-landing’

The threat of a US recession has largely disappeared, but growth in 2024 will be lower than last year, as the main components of final demand - domestic consumption, domestic investment, external demand and lower fiscal pushes from both federal and state governments – will be much weaker than that seen in 2023. The government-engineered post-covid boosts to activity are no longer there, and with the labour market and inflationary pressures both expected to weaken over H2, so this slow-down in growth will pave the way for the Fed to start cutting interest rates this autumn.

Falling real incomes will act as a drag on growth

Consumption is showing clear signs of slowing, predicated largely on the huge decline in real income growth that has been seen this year. Real income growth in 2023 (4.2%) was almost double the long-run average, while this year the figure will be less than half this amount - approximately 1%-2% - and with much of this growth already having been seen. This fall in consumer income is almost entirely behind the weaker retail sales numbers and slowing consumer demand figures that are now being seen. The consequence of this is that domestic consumption will not be able to support economic growth this year in the same way that it did last year.

Bank lending expected to continue to decline

The lagged impact of the Fed’s monetary tightening is now increasingly being felt in the business sector, with financing costs being faced by SMEs (which employ roughly half the US workforce) now approximately 7% in real terms. This is seeing demand for credit tail-off sharply. On top of this, the growing commercial real estate crisis in the US is increasingly dragging on the appetite of banks to lend money, particularly so at the regional banking level. The consequence of these dynamics is that the stock of bank lending to the corporate sector is now contracting, leading to a scaling back in both capex and hiring plans and adding a further significant headwind to what is already a more difficult growth outlook.

Rate of unemployment expected to rise

We are more pessimistic than the Fed on the outlook for the labour market going forward and expect a deterioration in the official payrolls numbers to start emerging as we move through Q3. Despite the resilience seen in payrolls to date, survey evidence is increasingly pointing to a slowdown in the pace of hiring. Furthermore, the growing increase in part-time relative to full-time positions being reported, plus the rising trend emerging in the jobless claims numbers, means we expect the rate of unemployment to rise above the 4% level the Fed is forecasting for end-year. This matters, as a weaker labour market will lower the Fed’s forecast of wages growth and, by implication, its outlook for inflation.

Inflation risks increasingly moving to the downside

The outlook for inflation continues to look increasingly benign. Nearly all the drivers behind the post-pandemic surge in inflation – food and energy prices, supply chain disruptions, rents, strong wages growth and margins - have now largely normalised or are in the process of normalising, and are already passing through into the lower PPI, CPI and PCE numbers now being seen. The “bumps in the road” seen in the Q1 inflation figures appear to be no more than residual seasonality issues, which are now working in the opposite direction. The main exception is retail margins, which while not growing, continue to remain high. But we expect margins to begin falling going forward as lower income growth and an exhausted stock of excess savings sees domestic consumption weaken. Accordingly, we see inflation risks as tilted to the downside.

First Fed cut to come this autumn

The expected slowdown in the labour market, diminishing inflationary pressures and a slowdown in domestic demand - collectively played out in lower growth numbers - will allow the Fed to cut interest rates this autumn, with our forecast remaining for a first cut to be delivered in September. However, the lagged nature of monetary policy decisions means the US economy is facing a lengthy period of weaker growth, leaving the Fed in the position of needing to expedite a series of further cuts if it wishes to ensure a ‘soft-landing’ for the economy.