Economic outlook for the US - Q1 2024

The growth outlook for 2024 remains soft, but with the risk of recession now seen as less of a threat then previously. The strong growth seen over Q3 (and expected into Q4) is the result of specific factors that will not deliver a further incremental lift to activity going forward. However, the Fed should be able to achieve its goal of delivering a ‘soft landing’. Inflationary pressures will continue to soften over the course of the year, with CPI returning to target during H2. This will require the Fed to cut rates quite aggressively if the real interest rate is not to rise to levels that will choke off growth. Starting in Q2, 100bps of cuts are expected over 2024.

Growth set to slow over Q1, but Fed expected to achieve its goal of a ‘soft-landing’

Despite strong activity seen in 2023 Q3, we expect growth to have slowed over Q4 and into 2024 Q1. This is predicated on the fact that much of the Q3 boost is attributable to one-off factors such as the increase in building activity from the CHIPS Act and the cost-of-living adjustments made to social security payments at the start of the year. In addition, the inventory build-up seen over the summer period looks unsustainable. While these factors will continue to support activity going forward, they will not offer further uplifts to growth. Accordingly, we expect the Fed to achieve its goal of securing a ‘soft landing’, but this is tempered by the fact that the risk of recession has not yet entirely gone away. Overall, we forecast growth to remain below trend over the course of 2024.

Domestic consumption expected to soften

Retail sales held up well over 2023, but this strength in consumption is showing signs of weakening and looks set to continue during Q1 as the boosts to spending seen last year (tax rebates, social security uplifts, run-down in excess savings) increasingly wane and the rising cost of credit and falling real wages crimp spending behaviour. In short, there are no signs that consumption is facing an imminent collapse, but a slowdown over Q1 and onwards looks largely unavoidable at this stage.

Fallout from the banking crisis continues to be felt

Despite the lack of new bank failures, the consequences of the banking crisis continue to be felt, with bank credit increasingly expensive and actually falling in real terms. The fallout from this is being seen in companies cutting back on capital expenditure and reducing holdings of inventories and – ultimately – labour. This presents a substantial headwind to growth. Similarly, the squeeze from both higher interest rates and tightening lending standards is crimping household spending plans, as evidenced by falling sales of big-ticket items such as cars and expensive white goods, which typically involve some form of credit being used. Furthermore, the previous boost to spending provided by the excess savings built up over the pandemic period looks unlikely to re-appear, given that remaining savings are now held by the top 20% of wealthiest households who typically have a lower relative marginal propensity to consume. This constrained corporate and consumer activity will be the main driver of below trend US growth going forward.

Pace of jobs growth expected to start to slow

The US labour market has so far proven to be remarkably resilient in the face of the monetary tightening delivered by the Fed. However, we expect the pace of job growth to show increasing signs of slowing going forward, although based on an expected slower pace of new hiring rather than rising layoffs per se. The recovery seen in the labour participation rate, plus a post-pandemic rise in immigration, is swelling the size of the labour force, pushing up the unemployment rate in the process but without an accompanying rise in jobs lost. Simultaneously, this will act to depress wages growth, with signs of this already being seen in a Quits rate falling back to pre-pandemic levels and pointing to wages growth returning to a level compatible with the Fed’s 2% CPI target, which we expect will be achieved by year-end. But it will be a slow and bumpy road and until the Fed is confident that the labour market is materially weakening it will continue to refrain from any suggestion that policy might be loosened.

No signs of meaningful recovery in the housing market seen yet

The slowdown in the housing market seen over 2023 is likely to bottom out over Q1 given anticipated lower interest rates. However, even in the face of falling official rates, mortgage rates will likely remain considerably higher than average rates on outstanding mortgage balances, meaning most current homeowners will choose to remain where they are rather than move house. This means that any recovery in volumes will be modest with the majority of sales being in the new homes sector, where house builders are able to offer temporary financial assistance to buyers. Accordingly, this slow pace of recovery, coupled with the lack of activity seen since 2022, will continue to act as a drag on the home-sensitive components of retail sales.

Inflation expected to return to target this year

Inflationary pressures are continuing to dissipate rapidly, and at a faster pace than the Fed was expecting. The core PCE deflator is forecast to end 2023 at around the 3.4/3.5% level, some 0.5% below what the Fed was expecting in its June forecasts. Much of this decline is attributable to a reversal in the factors that drove inflation higher during the pandemic period, ie easing supply chain bottlenecks, falling margin inflation, lower rents and falling food and energy prices. These factors have more than offset the relatively slow pace of wages growth moderation that has been seen and which was previously considered by the Fed as being key for bring inflationary pressures down. We expect CPI to return to target in 2024.

First Fed cut could be delivered as soon as end-Q1

For the Fed this means that the current interest rate hiking cycle has ended and that the next move in rates will be lower. Although official FOMC policy is still that a further interest rate hike remains an option, this assertion no longer has credibility in the market and as inflation continues to fall so the FOMC will need to cut rates sooner if real rates are to be prevented from rising too far. Unfortunately the Fed remains scarred from the transitory inflation fiasco and the credibility re-building exercise this has necessitated. This is keeping policy tighter for longer than is necessary. But it means that when policy is finally reversed, rate cuts can be expected to come quickly. While we do not completely rule out a first 25bps cut being seen as early as end-Q1, the strength still being seen in the labour market means our baseline scenario is for a first cut to be delivered in Q2.