Viewpoint
June 28, 2024 | 15:11
July 28, 2024
The New Normal |
The economy in 2024 is shaping up to be a very different environment for businesses to operate than the 2023 vintage as we long forecasted it would be. GDP growth in 2023 rebounded strongly as seemingly Teflon consumers shrugged off rising prices and a highly restrictive monetary policy. Real consumer spending clocked in north of 3.0% growth in the second half of 2023 as GDP over the same period averaged a sizzling 4.2% as immigration and population surged. But now with the final Q1 U.S. GDP numbers in the bag, it’s obvious the adjectives used to describe the economy, consumer spending, and the labor market in 2023—such as resilient, strong, and tight—no longer fully apply. While the third estimate of first quarter GDP released earlier this week showed a modestly better headline growth rate of 1.4%, up from 1.3%, the upgrade was somewhat misleading. The underlying details on consumer spending were actually considerably weaker than the second and initial estimates. |
Consumers struggled more in the first quarter than previously advertised and so far in Q2, spending growth isn’t off to a much better start. Overall real consumer spending managed to increase at a 1.5% annualized rate, a pretty big step down from the initial estimate of 2.5% and less than half the 3.3% growth rate recorded in the fourth quarter of last year. Durable goods spending plunged at a 4.5% pace, almost 4 times the initial estimate of a 1.2% drop. Notable downward revisions were also seen in consumer non-durable goods and services spending (Chart 1). Helping to mask this consumer weakness was an upgrade in state and local government spending, and residential and business investment that already appeared to be relative bright spots for the economy. Bottom line, the U.S. consumer, which makes up around 70% of GDP, probably isn’t the resilient, energizer bunny growth engine it once was in this post-pandemic expansion. Slowing job and earnings growth, exhausted pandemic savings, and higher real interest rates on their credit cards and auto loans are taking a toll and sapping some consumers’ willingness and ability to spend. The June payroll report (to be released July 5) is expected to show fewer gains of around 190k jobs and year-on-year earnings growth at a three-year low. We currently forecast second quarter consumer spending growth at a middling 1.8% annual rate, even with the better May personal spending report, and expect spending to average only 1.6% in the second half of 2024. If realized, real consumer spending will slow from 2.7% Q4/Q4 in 2023 to a modest 1.6% Q4/Q4 in 2024. The Fed’s restrictive monetary policy is doing its work to temper overheated demand. Other important data released this week on wholesale and retail inventories for May point to a concerning business inventory pile-up that could add at least a percentage point to U.S. GDP growth in Q2 (Chart 2), but may trigger an even bigger pull-back in business inventories, business investment, and manufacturing activity in the second half of 2024. Non-defense capital goods orders are already on the decline, dropping 0.6% in May and down 0.2% from a year ago, signaling a lackluster near-term equipment spending and manufacturing outlook (Chart 3). Adding to the slowdown story, May’s 11.3% plunge in new home sales and 2.1% drop in pending home sales capped another week of disappointing housing data that suggests a sizable 5.0% annualized drop in Q2 residential investment and lower broker commissions to boot. |
Injecting more volatility into the mix, the advance goods trade deficit blew above $100 bln in May, pointing to a real trade deficit in Q2 of over $1.0 trln annualized. The highest quarterly trade deficit since the start of 2022 may subtract around 1.3 percentage points from Q2 GDP growth. Putting it all together, the plenty of gray clouds on the horizon will likely keep U.S. GDP growth at a subdued 1.6% annualized pace in Q2 and hold it in a tight 1.0%-to-1.5% range in the second half of the year. Let’s just call it what it is: the new normal. |
FOMC Policy: Waiting for Good-data |
The parade of major data for May has now marched past with the Fed’s rate-cutting confidence likely increasing at least a little. But we still judge such confidence is well below the level it was before inflation pressures boiled over for the first few months of the year. This week’s PCE price indices, as their CPI cousins did a couple of weeks ago, served evidence that Q1’s disquieting inflation burst was probably a “bump” on the path to price stability and not a portent of more persistent pressures. But additional evidence is needed. |
The total PCEPI was unchanged in May, pulling down the yearly change by a tenth to 2.6% (Table 1). Both the core index and the core services ex-housing metric (a.k.a. supercore) increased by 0.1% m/m. Unrounded, the core PCEPI posted its lowest monthly move since November 2020. This slowed the core inflation rate by two-tenths, also to 2.6%, with the annual change for the supercore index down a tick to 3.4%. The six-month trends showed trivial improvement, still influenced by Q1’s burst. But the three-month trends did improve meaningfully, thanks to the stellar monthly results. For example, the core index was 2.7% annualized, down from 3.5% in April. The core PCEPI’s latest three- and six-month trends compare to the 4.5% and 3.0% readings, respectively, at the end of Q1 that, in turn, spurted from sub-2% results at the end of last year. Back in December, the 1.6% and 1.9% outcomes were the stuff of Fed rate cuts, not only in the mind of the market (more than six rate cuts were priced in at one point) but also of some Fed officials. Elsewhere, the labour market data were more mixed as far as Fed confidence building was concerned. Recall, the three-month growth trends remained well in the 200k-range for payrolls and above 4% annualized for average hourly earnings. However, household employment had a hefty fall in May (now down in 4 of the past 6 months) and the jobless rate rose a tenth to 4.0%, matching a 30-month high. Meanwhile, this week’s third estimate of real GDP growth for Q1 showed a 0.1 ppt upgrade to 1.4% annualized, which is still in a very comfortable ‘soft landing’ gear. When Fed Chair Powell talked “totality of the data” during the recent post-FOMC presser, he specifically mentioned the inflation and labor market data along with “what’s happening with growth”. At the time (June 12), the Fed was already starting to see “modest further progress” towards the 2% target, an assessment that has since been reinforced and helps further build Fed confidence. We look for the data flow to continue this pattern in the months ahead. Currently, the market is pricing in 66% odds of a Fed rate cut in September and a total of just under two (1.8) moves by the end of the year. We continue to keep our call for rate cuts in both September and December. |
Looking Under the (Industry) Hood of the Economy |
Alongside the release of revised real GDP data for the first quarter, the BEA unveiled the latest set of industry figures. Real GDP grew a robust 2.9% in the past year but downshifted to a 1.4% annualized rate in the latest quarter. What do the industry data say about the economy’s earlier resilience and recent loss of momentum? Still going strong:
Growing more moderately:
Struggling:
Bottom Line: There are plenty of industries performing well enough to suggest the economy’s expansion is well grounded. But weakness in the food and housing sectors, and softness in a few services industries, suggest growth will remain subdued until consumers get some relief from elevated interest rates. A soft landing remains intact. |