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Provided the economy transitions to 2% growth and 4% unemployment, inflation should continue its steady downward trend.

Our baseline U.S. economic forecast for 2024 can be summed up by the number 2024 – 2% growth, 0 recessions, 2% inflation and unemployment staying at roughly 4%. However, there are clearly risks that could divert us from that path.

On economic growth, demand is gradually easing following a surprisingly strong 2023. Real GDP growth in 3Q23 was 3.0% year-over-year powered by strong gains in consumer and government spending, resilient investment spending, inventory restocking and improving international trade. All of these areas should see slower growth going forward.

Consumer spending should grow more slowly as job gains diminish and banks gradually tighten lending standards. That being said, while younger and poorer households are showing signs of increased financial stress, on aggregate, consumer financial conditions are not nearly as dire as they were before the Great Financial Crisis, and we expect consumer spending to grow more slowly rather than shrink.

Capital spending could be more challenged as businesses react to higher interest costs and slowing revenue growth. Moreover, the longer high interest rates remain in place, the greater is the risk of a surge in small business bankruptcies. However, the outlook for capital spending is not entirely negative, as booming spending on artificial intelligence and federal government incentives for semi-conductor manufacturing should be able to offset weakness due to declines in the construction of retail and office facilities.

After improving in 2023, international trade should drag on growth in 2024, reflecting a still very-high dollar and sluggish global growth. Meanwhile, government spending growth should slow as federal spending is constrained by Washington gridlock and state and local spending is trimmed in line with a slowing U.S. economy.

All of this being said, we believe that demand growth in the U.S. should still be strong enough to support 2% real GDP growth in 2024. But how about supply?

The unemployment rate has been in a narrow band of between 3.4% and 4% since December 2021 and could stay in this range in the year ahead. If it does, then all growth in employment in 2024 would have to come from growth in the labor force. This will be challenging – just-released Census projections show the population aged 18-64 rising just 0.1% in 2024, in a long-standing trend reflecting the aging of the baby boom generation. However, tight labor markets should encourage stronger immigration and some further gains in labor force participation. In addition, productivity has seen solid gains over the past year with output per worker rising by 1.1%. This could improve further in the year ahead, allowing for 2% real GDP growth without overheating the economy. 

Provided the economy transitions to 2% growth and 4% unemployment, inflation should continue its steady downward trend.

One way to appreciate this is to break CPI inflation down into food, energy, shelter and everything else. 

Food prices soared in the pandemic, reflecting fiscal stimulus and supply-chain disruptions – a trend that was extended by Russia’s invasion of Ukraine. These effects are now fading and real food spending has declined for much of the last two years, reflecting a squeeze on lower and middle-income consumers.  Restaurant spending has proven more robust, reflecting a post-pandemic bounce-back. Nevertheless, baring another supply shock, we expect these forces to continue to erode food inflation in 2024.

Turning to energy, after slumping and surging in recent years, oil prices have fallen back to a more normal range of USD 80-90 per barrel of West Texas intermediate crude. Importantly, the tragic events in the Middle East have not, as yet, had a major impact on oil prices. Going forward, a combination of a sluggish global economy and increased output from the U.S. and non-OPEC nations should more than offset continued reductions in OPEC and Russian output, allowing oil prices to move sideways or down in the year ahead.

Importantly, the spread between gasoline prices and crude oil prices has narrowed significantly in recent months from very elevated levels. This has allowed gasoline prices to fall sharply and should allow for further modest declines in the year ahead. Relatively high natural gas inventories should keep natural gas prices steady or falling in the year ahead, contributing to a similar pattern for electricity prices. All told, we expect the energy component of CPI to post modest year-over-year declines throughout 2024.

Shelter comprises almost 35% of the CPI basket, of which roughly 8% is actual rent and 26% is “owners’ equivalent rent.” The government uses a complicated procedure to estimate these concepts that causes measured inflation in these areas to lag behind changes in rents negotiated in the market place. While this is hardly ideal, it does help economists predict trends in shelter inflation well in advance based on data on new leases, and given this trend, we expect shelter inflation to fall steadily throughout next year.

Finally, there is the rest of inflation, which has been boosted in recent years by a very restricted supply of new and used cars, a resurgence in airline travel following the pandemic, general supply chain issues and, to some extent, the impact of higher wage growth. However, all of these trends are easing, suggesting that this area of inflation will also moderate in the year ahead. 

Pulling all of this together, and recognizing that consumption deflator inflation normally tracks a little cooler than CPI inflation, suggests that the year-over-year change in the consumption deflator is still on track to fall below 2% by the fourth quarter of 2024 – well ahead of the Fed’s current projections.

So, overall, a base case forecast of 2024 for 2024 – 2% growth, 0 recessions, 2% inflation and 4% unemployment. However, it should be recognized that there are many potential risks to this outlook, including a U.S. election, the lagged consequences of higher interest rates and very significant geopolitical tension. Any of these issues, or something else entirely, has the potential to trigger recession in a slow-growing U.S. economy, making 2024 a year for hope but not complacency.