Viewpoint

December 20, 2024 | 14:16

December 20, 2024

Economist

Deputy Chief Economist and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Michael Gregory , CFA

Deputy Chief Economist and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Our Thoughts

Sticky Inflation-Toffee Pudding

America’s monetary policymakers headed home for the holidays after this week’s confab. They departed D.C. not with visions of sugarplums dancing in their heads but fretting about dogged inflation on the ground and dilating confidence intervals around their inflation forecasts.

In the presser, Chair Powell said the “single biggest factor” why FOMC participants pared their expectations for policy rate cuts next year (to a median of 50 bps from 100 bps before) might be that “inflation has once again underperformed relative to expectations”. He added: “the slower pace of cuts for next year really reflects both the higher inflation readings we’ve had this year, and the expectation inflation will be higher.” In the FOMC’s Summary of Economic Projections (SEP), the median forecasts for total and core PCE inflation were lifted for this year and next, with core by at least a couple of tenths (now 2.8% and 2.5% Q4/Q4, respectively). Indeed, core inflation now only returns to the 2.0% target in 2027, a year later than in the previous SEP.

November readings emphasize inflation’s stubbornness (Table 1). The yearly change in core PCE prices was 2.8%, smack dab in the middle of the 2.6%-to-3.0% range of the past nine months (and, unrounded, it’s also a seven-month high). The ‘supercore’ measure is still running hot (above 3%) and the CPI’s counterparts are even higher. In dissecting recent results, Powell said: “Housing services inflation actually is steadily coming down now, albeit… slower than hoped. And we’ve had recent high readings from non-market services and some bumpiness for goods.” Powell also said part of the stickiness reflects the fact that “we are lapping very low readings of late last year”.

Indeed, in December 2023, three- and six-month annualized core PCE inflation rates were 1.6% and 1.9%, respectively, which caused visions of rate cuts to dance in policymakers’ heads last holiday season. This instead became a nightmare, as the former spiked to 4.4% in March with the latter eventually drifting above 3%. Businesses’ beginning-of-the-year price adjustments seemed to occur en masse, perhaps mirroring a move away from the more frequent intra-year adjustments soon after the pandemic and amid the supply chain disruptions. Is this destined to occur again, against the background of sturdy economic performance? The adage, ‘once burned, twice shy’, might explain why participants opted to be more cautious.

The increased policy caution also reflects the escalating inflationary risk of tariffs or other policies that could stimulate the economy under the incoming Trump Administration. Apart from raised inflation projections, policymakers also see more net upside risk surrounding their forecasts. The latest diffusion index for the core inflation forecasts (with +1 meaning 100% of participants see net upside risk) was 0.79. Apart from the December 2021-to-December 2022 period, when inflation was spiking to 40-year highs, this metric has not been this high since it began in 2007.

Perhaps Powell said it best: “when the path is uncertain you go a little bit slower.” And, to end on an upbeat note… this time last year the Fed was forecasting 75 bps worth of easing for this year, and we got 100 bps. Happy thoughts!

Economy: Go, Go, Go

The economy is barreling into the new year with a good head of steam. The Commerce Department revised up third quarter growth by three notches to 3.1% annualized. Rather than downshifting, the economy sped up a bit. The revisions were widespread, spanning nonresidential investment (4.0%), government spending (5.1%), and even exports (9.6%) despite the lofty dollar. The only weak spot was residential construction, though more recent data flag a pickup. Existing home sales jumped nearly 5% in November, stretching their two-month gain to more than 8%, albeit from 14-year lows. It’s a start.

Consumers, as usual, are driving the train, spending at a 3.7% clip in the third quarter and 3.0% in the past year. That’s why retail outlets accounted for more than a third of growth in industry GDP last quarter. And, holiday sales look merry with a solid 0.3% advance in real personal spending in November. That should keep a 3-handle on the Q4 pace, which is why we bumped up our GDP growth call to 2.1%.

This all means the sprightly economy barely lost a step in 2024 with growth of around 2.8%, the mildest of decelerations from 2.9% in 2023. For what it’s worth (which isn’t much), even the leading indicators index turned positive last month after coasting head-first downhill for three years. Not sure what it’s supposed to lead, as growth averaged a decent 2.3% in the period, though it at least captured the downshift from the stimulus-hyped 6.1% pace of 2021. Thanks for coming out.

While we left our 2025 growth call unchanged at a healthy 2.3%, the range of uncertainty is especially wide. Growth could outperform again if Trump’s tax policy measures (namely, a cut in corporate rates and the repeal of taxes on tips, overtime pay and seniors’ benefits) are expedited into law. But with the administration and Congress likely to be preoccupied with his protectionist agenda (starting on Inauguration Day), the fiscal goodies could take a back seat for a while and may also come with a few lumps of coal in the spending sock. Conversely, the economy could undershoot the mark if a trade war breaks out. Toss in difficult USMCA talks, trade tensions with China, lofty stock valuations, ongoing conflicts in Ukraine and the Middle East, and it’s safe to say that next year won’t be boring. We could still land at 2.3% growth, but after a lot of hand wringing and a little hair pulling.