We once again find ourselves reversing our position on the overall direction of the economy for 2024, as the resilience of consumer activity drives surprisingly strong output growth that appears to be sustainable. That outlook is dashing hopes for Fed easing anytime soon. The widespread expectation that the FOMC would cut rates in June is fading fast, and while both Fed funds futures and the Fed’s own dot plot indicate three rate cuts this year, we’d bet on two – or less.
Labor Market
We’ll start this quarter’s analysis with a look at the labor market, because that’s where much of the story lies. The March jobs report brought the usual upside surprise, with non-farm payrolls growing by 303,000 vs. a forecast gain of about 200,000. Unlike in some recent reports, the gains were relatively broad-based: healthcare led the gains, followed by government jobs, leisure and hospitality, construction, and retail trade. Notably, employment in the leisure and hospitality sector is now back to its pre-pandemic level, though it has yet to catch up to where it would be accounting for normal growth since then.
The unemployment rate ticked down from 3.9% to 3.8%, in spite of a two-tick increase in the labor force participation rate to 62.7%. The two negative data points in the report were average hourly earnings and the underemployment rate. Year-over-year wage growth fell to 4.1% from 4.3% in February. While that rate of earnings growth was in line with the forecast, it’s the lowest since June 2021, and it’s barely above the inflation rate.
The U-6 underemployment rate – those unemployed, plus those employed but looking for a better job and those employed part-time but looking for full-time work – held steady at 7.3%. However, it’s risen steadily since the end of 2022, when it reached a low of 6.5%. Much of this is due to an increase in part-time employment for economic reasons, which was up 18% from May 2023 to January 2024, though it has declined by 3% since then. According to the Household Survey, total part-time employment increased by 525k in March, while full-time employment declined by 27k. This trend could temper the inflationary impact of overall payroll growth somewhat, but it’s still unlikely that the Fed will commence easing soon in the face of these non-farm payroll gains.
The pattern for most of 2023 was strong initial non-farm payrolls releases followed by sharp downward revisions the following month. However, February’s initially reported gain of 275,000 was revised lower by only 5,000 jobs. January’s latest estimate was revised upward by 27,000 to 256,000, but that’s still well below the initial estimate of 353,000.
We’ve maintained that these gains do not reflect true job creation. The economy recovered all the jobs eliminated during the pandemic shutdown by June of 2022, but it has yet to catch up to where non-farm payrolls would have been had the economy never been shut down to begin with, accounting for the normal growth trend prior to March of 2020 – we’re still nearly four million jobs behind. Add in the fact that an estimated five million jobs last year came from net immigration, and we’re woefully behind the growth curve.
However, while that gap was widening throughout the third quarter of last year, it has been narrowing since November. Continued job growth above 250k a month will narrow it further (though it will take a long time to reach equilibrium), and will likely keep the Fed on the sidelines, barring some strange confluence of factors that causes a decline in inflation in spite of relatively strong job growth.
Housing Market
The growth in construction employment in March – the largest since May 2022 – was welcome, as housing availability remains dependent on new home sales. Existing home inventories remain extremely tight, with supply at less than three months, roughly the same as a year ago. New home sales are up 6% year-over-year, in spite of the average 30-year fixed mortgage rate being about 25 basis points higher.
As a result, home prices continue to rise overall, with the S&P CoreLogic Case-Shiller 20-City Composite Index up 6.6% year-over-year in January, the highest pace since November 2022. The Composite Index has risen for 11 consecutive months, and all 20 markets in the index were up year-over-year as of January. However, only nine markets posted monthly gains in January, the first time less than half of the markets in the index increased in a month since January of last year, so higher mortgage rates are taking their toll in some areas.
Meaningful relief on the mortgage rate front isn’t likely anytime soon, given the strength of the economy and the inflation trend. Another factor keeping inventories tight is demographics: boomers are staying in their homes longer, keeping existing home inventory off the market.
Consumer Activity
Personal consumption was up nearly 5% year-over-year in February, higher than in January but below the pace seen over the last two years. Still, that’s a healthy rate of consumption that is sufficient to keep the economy humming – and inflation from coming down.
Spending on travel remains brisk; global tourism in 2024 is projected to generate $11 trillion in spending and create 500 million jobs worldwide. Clothing and food services sales were also up year-over-year as of February. Of course, some of the increase in spending has to be attributed to higher prices. However, we’re firm believers in anecdotal evidence, and one need only try to book a reservation at a popular restaurant on short notice, even on a weeknight, to know that people are dining out at a pace that suggests a willingness to spend. And the same holds true when traveling; that empty middle seat is a rarity when flying these days.
GDP Growth
All of this has led to stronger-than-expected growth numbers in recent quarters. And while growth is likely to slow, it’s also likely to continue to top expectations. 2023 Q4 output growth was 3.4% year-over-year, “in large part due to an increase in Americans making and spending more. In addition, the economy added 2.7 million jobs in 2023,” according to the Bureau of Economic Analysis. For the full year, GDP grew 2.5%, vs. 1.9% in 2022.
The Atlanta Fed’s most recent GDPNow forecast for Q1 projects GDP growth at an annualized rate of 2.5%, with the Blue Chip consensus slightly lower at 2.0%. However, that’s still above where those forecasts were just a couple of quarters ago. It appears that the elusive soft landing may in fact become a reality – or at least we may see what one recent report referred to as a “deferred landing.”
Inflation
CPI is up 3.2% year-over-year as of February, a tick higher than in January. Headline inflation has averaged 3.3% since June 2023, around the time of the last Fed rate hike, a clear indication that inflation is sticky, and that the Fed does not have prices under control. With continued strong consumer activity, more spending out of Washington (and more likely to come, in an election year), and gas prices up 15% since late January heading into the summer, it’s unlikely that inflation is going to move downward toward the Fed’s target of 2% anytime soon.
And while the Fed’s preferred inflation gauge, the core PCE deflator, is lower than CPI at 2.8% year-over-year (down a tick from January), that measure also remains higher than the central bank’s target, and bringing it down to that level will be a challenge given the current labor market and consumer activity.
Yield Curve and Monetary Policy
As of this writing, the two-year Treasury yield is 4.65%, up 42bp from year-end; the ten-year yield is 4.31%, up 43bp; and the curve remains inverted for a 21st consecutive month. The current inversion of 34bp is about 20bp below the average over that period. Both the two- and ten-year yields are near their 2024 peak levels.
The Fed’s most recent dot plot maintained expectations for three 25bp rate cuts in 2024, with a range of estimates from zero cuts (two participants) to four (one participant). Fed funds futures indicate an implied probability that mirrors the dot plot, with a 33% probability of three cuts as of this writing, and a range from zero cuts (2%) to five cuts (4%) by year-end. The futures market maintains a 51% probability that the first rate cut will occur at the June FOMC meeting.
It’s noteworthy that after the December 2023 FOMC meeting, Fed funds futures projected an implied probability of six rate cuts in 2024, with the first cut coming in March. Of course, the March FOMC meeting has come and gone without rate action. Much of the futures market’s optimism has faded in the wake of stronger-than-expected economic data, higher-than-expected inflation data, and recent Fed-speak that has indicated a bias toward easing later rather than sooner.
Conclusion
We anticipate continued upside surprises in the payrolls and inflation data, and a resilient consumer in 2024. As a result, we expect just two rate cuts in 2024 at most, with the first coming no sooner than July. Chairman Powell has often repeated the assertion that policy will be data-dependent. If the data remain strong, rate cuts later in the year, as the Presidential election approaches, will appear to be politically motivated, and this Fed has been more steadfast than most in recent memory in its determination to avoid that appearance.
While the prospect of little downward movement in rates has implications for lending – especially mortgage lending – and credit, including credit cards and other variable-rate products, a stronger-than-expected economy should offset some of those concerns, especially given that it’s likely to be driven by healthy job gains and consumer spending. This sets the foundation for a 2024 that may not bring the rate environment that many have been hoping for, but shouldn’t result in the economic downturn that many had feared.