US economic outlook: getting back to normal

The US economy's ongoing normalization has progressed further through the second quarter. Amid healthy consumer fundamentals, we have revised up our GDP forecast for 2024 by 30 basis points (bp) to 2.5%, and for 2025 by 20 bp to 2.1%. CPI inflation remains stubborn, prompting a 40 bp upward revision to 3.1% to our headline CPI forecast for 2024, and a 20 bp gain to 2.5% for 2025. Stronger inflation and growth reaffirm our view of a cautious easing cycle from the Fed. Hence, we now expect just two interest rate cuts in 2024 before four further cuts next year. We see a policy rate of 3.875% by year-end 2025. The combination of a higher policy rate and further economic resilience prompts us to lift our 2024 year-end 10-year Treasury yield forecast by 20 bp to 4.4%.

• Underlying resilience in consumption data prompts a 30 bp upward revision to our annual growth forecast to 2.5% in 2024.
• CPI inflation stickiness in 1Q24 leads us to revise our headline forecast to 3.1% in 2024 from 2.7% previously.
• Cautious Fed communications and broad momentum in the economy supports fewer rate cuts in 2024.
• We now see just two cuts this year starting in 3Q24, and four additional rate cuts in 2025.
• This macro backdrop and higher policy path leads us to raise our year-end 10-year Treasury yield forecast by 20 bp to 4.4%.

Stickiness in 1Q24 CPI readings has prompted a 40 bp upward revision to our 2024 CPI forecast to 3.1%. However, after several upside surprises in the first quarter, the April CPI report showed an encouraging softening of both headline and core inflation. Despite stubbornness in most core services (see Figure 1), disinflation in shelter continues to progress gradually. Further, we estimate that the surge in motor vehicle insurance inflation may be overestimated in the CPI prints. In our view, a turbulent disinflation process will not deter the FOMC's commitment to easing policy later this year, especially since the Fed's preferred inflation gauge - core PCE inflation – moderated to a more encouraging three-year low of 2.8% in March.

Figure 1: US CPI subcomponents 

Table 1: Key US forecasts

The May FOMC meeting featured dovish commentary from policymakers and their patience to not begin the easing cycle. Chairman Powell reiterated that "greater confidence" was needed to begin rate cuts after inflation showed a "lack of further progress" towards the committee's long-run 2% inflation objective. Our outlook of cooling inflation and more moderate sequential GDP growth in 2H24 aligns well with the Taylor Rule¹ (see Figure 2), which prescribes that rate cuts will be appropriate later in 2024. However, recent data and Fed communications prompt us to revise our prior expectation of three rate cuts in 2024 to just two beginning in 3Q24, bringing the year-end policy rate to a range of 4.75-5.0%. We also expect a more resilient growth outlook and sticky inflation backdrop in 2025 to limit policy easing next year, and now expect just 100 bp of rate cuts rather than 150 bp.

Figure 2: Taylor Rule under different economic scenarios

The April nonfarm payrolls report illustrated a continued healthy rebalancing in labor market conditions. The economy added a moderate 175 000 jobs, bringing down the three-month average of job gains to 242 000 from 269 000 in March. The unemployment rate rose by 0.1 percentage points (ppt) to 3.9%, while a just 0.2% increase in average hourly earnings supported a moderation in annual wage growth to 3.8%, its slowest pace in three years. Additional labor market data corroborates the view of broad-based rebalancing with job openings cooling to 8.5 million, the lowest number since February 2021. The US quits rate also eased further to 2.1%, indicative of lower churn and more employees staying put. That's a positive sign for more modest wage growth in the future. Layoffs also declined in March, to 1.4 million, still well below the pre-pandemic average of 1.8 million. Finally, hiring activity continues to normalize, with March's 5.5 million hires the slowest post COVID-19 pace since January 2018. 

Figure 3: US labor differential and unemployment rate 

While the consumer confidence index reading fell from 103.1 in March to 97 in April, broader measures of economic activity point to ongoing divergence in sentiment versus realized spending behavior. The US savings rate declined to 3.2% in March – its lowest level since October 2022 - as real consumer spending growth of 0.8% outstripped a softer 0.2% gain in real income growth (see Figure 4). Core retail sales rose a robust 0.95% in March. While gross labor income growth has moderated from double-digits in early 2022, it remains firm at 5.8% in annual terms, pointing to steady income growth and continued consumption momentum. The healthy backdrop for consumers has translated into optimistic earnings expectations, with the S&P 500's 12-month forward earnings-per-share growth at a strong 9.3%, up from 0.9% in April 2023. Despite the optimistic outlook for consumers, however, purchasing manager surveys remain depressed. The ISM manufacturing survey fell back into contraction in April, declining by 2.3 ppt to 49.1. The ISM services index also fell under 50, for the first time since December 2022. We expect survey data from consumers and corporates to remain downbeat in the months ahead amid uncertainty regarding the policy path and a gradually loosening labor market.

Figure 4: Monthly consumer spending and income growth