The U.S. Economy Refuses to Slow Down

The good news for workers and businesses is that hiring and sales are still rising briskly. The potential wrinkle is that underlying inflation still seems a bit faster than 2%.

The U.S. economy continues to defy the expectations of the pessimists who believed that consumer prices were destined to keep rising at double-digit rates unless millions of people were forced into joblessness, as well as the expectations of the pessimists who believed that post-pandemic normalization of fiscal and monetary policy would push the economy into a downturn.

Instead, the U.S. seems to be settling nicely into a new normal of ~6% yearly nominal growth. That is a great outcome for Americans—as well as everyone else in the rest of the world who relies on the U.S. market for exports—but it may not be consistent with market pricing of substantial interest rate cuts.

Consider how the influential Federal Reserve governor Christopher Waller framed the policy outlook in a recent speech:

Based on economic activity and the cooling of the labor market, I am becoming more confident that we are within striking distance of achieving a sustainable level of 2 percent PCE inflation…Risks that would delay or dampen my expectation for cuts this year are that economic activity that seems to have moderated in the fourth quarter of 2023 does not play out; that the balance of supply and demand in the labor market, which improved over 2023, stops improving or reverses; and that the gains on moderating inflation evaporate.

Waller seemed confident that the likeliest outcome would be a continued slowdown in nominal growth. But all of the factors that Waller warned could limit the scope for rate cuts already seem to materializing:

• Underlying domestic demand¹ now looks like it will rise around 3% after inflation in 2023Q4, which would be exactly in line with the torrid average pace in 2023Q1-Q3

• Wage growth seems to have stopped decelerating right as the passthrough from measures of job market churn to wages seems to have weakened

• Many of the impulses that contributed to the observed slowdown in inflation are either fading or gone, with some notable categories now moving in the wrong direction

None of this means that the U.S. “needs” a downturn to get back into balance. Current macro conditions are the best they have been in decades, if not ever, and policymakers should do what they can to keep the good times going. It does suggest, however, that case for lowering interest rates is relatively weak.

Jobs, Incomes, and Spending

As of December, employment was still rising briskly.² Moreover, the apparent slowdown in wage growth in 2023H2 seems to have vanished. For most workers in the U.S. private sector, wages are still rising slightly faster than 4.5% a year. The annualized average monthly change in hourly pay for nonmanagerial workers outside of leisure, hospitality, and retail in October-December 2023 was 4.6%, which is barely distinguishable from the July 2022-July 2023 monthly average of 4.8%. An unusually weak reading in August 2023 is the only reason why it looked as if wage growth had slowed over the past 18 months.