With solid economic growth, low unemployment and most of the journey back to 2% inflation completed, the U.S. economy should continue to provide a rising tide to support most investment boats for the rest of this year and into 2025.
The economic expansion, which started with a very swift rebound from the pandemic recession in April 2020, has now entered its fifth year. However, while growth remains a little stronger than expected and inflation a little hotter, the broad trend is of an extended expansion powered by voracious consumers, a surge in immigrant workers and competition suppressing inflation. The economy has now survived its cyclical fever and will likely continue on a path of mildly moderating growth and inflation unless and until it is hit by some unexpected substantial shock.
The first impression presented by recent GDP numbers is one of sharp deceleration, with real GDP growth falling from 4.9% annualized in the third quarter of 2023 to just 1.3% in the first quarter of 2024. However, first impressions can be deceiving and are in this case. Most of the measured slowdown was due to a sharp downturn in net exports and inventory accumulation, the two most volatile and, arguably, mis-measured components of GDP. Excluding these sectors and looking instead at final sales to domestic purchasers, real growth downshifted much more modestly from 3.5% in the third and fourth quarters of 2023 to 2.5% in the first quarter of 2024. Early estimates suggest real GDP growth of roughly 2.5% in the second quarter, continuing a growth trend that is well above the Federal Reserve’s (Fed’s) estimate of the long-run growth potential of the U.S. economy, currently pegged at 1.8%.
This growth is particularly remarkable given the widespread recession fears of a year ago and is mainly due to two factors. First, consumer spending has remained remarkably strong even in the face of dwindling pandemic savings. With an extended period of positive real wage growth and significant recent gains in wealth, consumer spending should continue to drive the expansion forward into 2025.
The other big surprise in the past year has been the resilience of investment spending in the face of higher interest rates and a credit crunch exacerbated by last year’s mini banking crisis. This resilience largely reflected healthy corporate balance sheets, federal government incentives and a surge in demand for AI-related technology. This also should continue into 2025, providing the potential for continued moderate economic expansion in the absence of a major shock.
Labor markets have also shown some moderation in recent months with the unemployment rate edging up to 4.0% from a low of 3.4% set in April 2023. Still, the unemployment rate has now remained at or below 4% for two and a half years, the longest such stretch since the late 1960s. Job openings have continued to ease but remain above pre-pandemic levels. Remarkably, despite some modest deceleration in recent months, non-farm payrolls have climbed by more than 2.8 million over the past year, as labor force participation has continued to rise and the labor force has been bolstered by a surge in new migrants. Equally remarkable, wage growth has continued to decelerate, with the year-over-year (y/y) change in average hourly earnings falling from 4.6% in April 2023 to 4.1% a year later.
This moderation in wage growth, perhaps reflecting both the long-term decline in unionization and a surge in relatively low-wage immigrant workers, is allaying fears of cost-push inflation. Still, progress toward lower inflation has stalled in recent months with a rebound in energy prices, only a very slow decline in shelter inflation and auto insurance rates still up by more than 20% y/y. We expect these impacts to gradually fade in the months ahead. However, we now expect CPI inflation to only fall from 3.4% y/y in April to roughly 3% by December. Equally importantly, we expect inflation as measured by the personal consumption deflator to ease only slowly from 2.7% in April 2024 to 2.6% by the end of this year and reach the Fed’s target of 2% in the middle of 2025.
Overall, the slowdown in growth and inflation has been delayed in 2024, somewhat frustrating Fed officials who expected a swifter moderation. However, with solid economic growth, low unemployment and most of the journey back to 2% inflation completed, the U.S. economy should continue to provide a rising tide to support most investment boats for the rest of this year and into 2025.