Economic Outlook: 'Unmistakable signs momentum is downshifting'
In their U.S. Economic Outlook for December released on the 14th, Wells Fargo economists noted resiliency in 2023, but growth in 2024 looks to be a sub-trend, at best.
Despite 525 bps of Fed rate hikes since March 2022, the U.S. economy has been more resilient in 2023 than many observers had anticipated. As we close out the year, we estimate that real GDP grew 2.4% in 2023.
But there are unmistakable signs that momentum in the economy is downshifting, and cracks are beginning to appear in the household sector.
The FOMC has now refrained from hiking rates for three consecutive policy meetings, and the odds of additional tightening in the coming months appear to be low. But the FOMC likely will refrain from easing policy for some time until it is confident that inflation is returning to its 2% target on a sustained basis.
As inflation recedes further in the coming months, the real fed funds rate will drift higher. Real interest rates have a more important bearing on the pace of real GDP growth than nominal interest rates. This passive tightening of monetary policy will exert increasing headwinds on economic growth.
A modest contraction in real GDP in mid-2024 remains our base-case view. Specifically, we look for real GDP to contract about 0.5% on a peak-to-trough basis between Q1-2024 and Q3-2024. If this projection is realized, then the downturn in real GDP would be one of the shallowest contractions in real GDP among the 12 recessions that have occurred in the post-World War II period.
We readily acknowledge, however, the economy could achieve a "soft landing" in 2024. But even if an economic contraction is avoided, the pace of real GDP growth over the next few quarters likely will be sub-trend due to the restrictive stance of monetary policy.
U.S. Resiliency in 2023, but Signs of Imminent Deceleration Appearing
Despite 525 bps of Fed rate hikes since March 2022, the U.S. economy has been more resilient in 2023 than many observers had anticipated. The consensus forecast in December 2022, as measured by the Blue Chip panel of economic forecasters, looked for U.S. real GDP to grow only 0.3% on an annual average basis in 2023. As the year draws to a close, however, we estimate that real GDP will grow 2.4% in 2023 (annual average). Moreover, real GDP growth has been broad-based over the main spending components. On a year-over-year basis, real GDP was up 3.0% in Q3-2023, with real personal consumption expenditures (PCE) contributing a bit more (1.6 percentage points) to the headline growth rate (Figure 1). Government spending tacked on 0.8 percentage points to overall GDP growth with fixed investment spending contributing 0.2 percentage points. Despite higher interest rates, healthy profit margins have allowed businesses to add to payrolls throughout the year. Solid growth in payrolls has lifted real income, helping to support growth in real PCE. Strong household balance sheets have also helped to underpin growth in real PCE.
That said, there are unmistakable signs that momentum in the economy is downshifting. If, as we project, real GDP grows at a sequential annualized rate of only 0.8% in Q4-2023 relative to the third quarter, then the year-over-year growth rate will moderate from 3.0% in Q3 to 2.5%. As noted earlier, employment continues to expand, but the monthly increases have downshifted. Payrolls increased at a monthly average rate of 312K in Q1-2023. That pace of growth slowed to 175K in the first two months of the fourth quarter. Manufacturing production has been more or less flat in recent months, and housing starts have trended lower since summer. Cracks are starting to appear in the household sector as delinquency rates, especially on auto loans and credit cards, have moved markedly higher in recent quarters.
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