Strong, But Not Too Hot: The U.S. Economy as of Mid-2024
The latest numbers on growth, inflation, and incomes suggest that the American economy is easing into a steady state growth regime with inflation still slightly faster than the Fed's 2% goal.
The dollar value of spending on goods and services by American consumers and businesses1 is still rising at the ~5.5% yearly pace that it has since the middle of 2022. Unless that changes—or unless the real production of goods and services sustainably rises by 3.5% a year—it will be difficult for inflation to persist around the Federal Reserve’s 2% yearly goal.
The good news is that the mismatch is relatively small, with output growing briskly at about 2.5%-3% a year even as inflation has decelerated slightly towards 2.5%-3%. This is a big improvement from two years ago, when the split between price and volume growth was far less favorable. Accelerating productivity2 and the unwinding of pandemic- and war-related supply disruptions are both responsible for this benign outcome.
The question for investors and policymakers is whether the current situation is sustainable with interest rates where they are. One risk is that the slowdown in borrowing, which so far has had little apparent impact on nominal incomes and spending, finally feeds into consumer spending, business investment, and hiring. That is motivating many analysts, including some who were warning against premature rate cuts as recently as two months ago, to call for the Federal Reserve to start moving as early as this week.
The wrinkle is that a substantial downward adjustment in rates is already priced in, even if the Fed does not begin lowering the policy band until later in the year. While short-end interest rates may seem high relative to recent history, they are currently priced to drop by about 1.5 percentage points over the next 12 months. Longer-term real interest rates on Treasury Inflation-Protected Securities (TIPS) are no higher than in 2004-2007, when underlying growth and inflation were weaker—and when the economy was much more dependent on borrowing as a substitute for rising incomes.
The alternative risk is that unreasonably rapid cuts in short-term rates would unlock tens of trillions of dollars in monetizable home equity, inflate risk assets even more, and potentially lead to an unwelcome acceleration in nominal spending and inflation.
While it is entirely possible that the Fed will want to recalibrate the level of short rates before the end of the year, they should be wary of overreacting to a slowdown that exists only in dubious forecasting models and is not (yet) visible in the data.
Stable Nominal Growth
Despite the occasional quarterly volatility in segments such as inventory builds/draws and the trade deficit, the most striking feature of the past two years is the relative stability of nominal domestic demand.