Smith's 2024 U.S. Economic Outlook
Summary:
The 2024 Smith's outlook for the U.S. economy calls for ongoing expansion, but at a slower pace and with considerable potential downside risk. Real GDP growth is expected at 1.8%, inflation at a little over 2.0%, and unemployment at around 4.0%. Barring any unexpected developments, the Fed should begin introducing interest rates cuts in June or July, with a year-end target of around 4.0%-4.25%. But the risks remain very present: intramural fighting over government spending, the Fed overshooting its inflation target, refinancing indigestion in the commercial property sector, and a plethora of external factors (which could be inflationary). The 2024 November elections are likely to be nasty, but not enough to derail the economy. All factors considered; our economic outlook is cautiously optimistic.
What Keeps Growth Intact?
In 2023, the demise of the U.S. economy and Fed rate cuts were consistently overstated. The expectation was that the Fed's rapid increases in interest rates would induce a recession. Instead, the inflation rate was lowered to more manageable levels, real GDP growth likely be 2.6%, unemployment stood at 3.7% in November and consumer spending remained in positive territory through year-end, though credit card balances are growing.
In 2024 we expect many of the same forces to continue. The main drivers for continued growth are consumer resilience, an end of the corporate earnings recession, greater business spending on AI, industrial construction, and tight labor markets. Although the energy transition from fossil fuels to renewables is uneven, disruptive and policy objectives aggressively unrealistic, the flow of federal (CHIPS Act and IRA) and private sector investment will still be felt in the revival of many parts of the country with EV plants and battery gigafactories. Changes in the country's economic structure will continue, though perhaps at a slower pace, in part due to growing consumer cautiousness vis-à-vis EVs and growing constraints to rapidly expanding the electricity grid's capacity to meet growing demand.
Why are labor markets likely to remain tight? The answer is a combination of early retirements, an aging workforce, net international legal migration to the U.S. being at its lowest levels in decades, lack of access to childcare, and new business startups. Related to this is a decline in labor force participation, which has fallen from 67.2% in 2001 to 62.7% as of November 2023. Reasons for the decline in labor market participation encompass an unwillingness for some workers to take jobs that do not offer remote work, retirement and younger generations prioritizing personal growth through acquiring new skills, education and training over searching for a job. The result is tight labor markets, which are likely to continue through 2024 and into 2025.
What Could Derail the Economy in 2024?
Our outlook for the U.S. economy faces several risks. These include the Fed keeping interest rates too high for too long, provoking a recession; a prolonged federal government shutdown sparked by a renewed battle over government spending; and the impact of rising consumer debt (U.S. credit card balances surged in Q3 2023 to a record $995 billion); dissipating pandemic savings; and the resumption of mandatory student loan repayments.
Another major area of concern is the commercial real estate (CRE) sector, which was hit hard by Covid-19, the change in work habits, and rising interest rates. In 2024 and 2025 there are $1.5 trillion in CRE loans coming due, with $500 billion alone this year. The office vacancy rate reached a record high of about 20% in the third quarter of 2023.
Some refinancing will occur, but property defaults appear ready to rise, which, in turn, could have a negative impact on regional banks, many of which have a high degree of exposure to CRE loans. Indeed, an April 2023 study by the National Bureau of Economic Research (NBER), notes: "If interest rates remain elevated and property values do not recover, default rates on CRE loans could reach levels comparable or surpassing those of the Great Recession." The report estimates that defaults could be between 10% and 20% of CRE loans, which constitute about a quarter of all assets held by the average US bank. Considering that 2023 witnessed two of the largest bank failures in U.S. history (Silicon Valley Bank and First Republic), the CRE issue bears watching.
The politics surrounding federal government economic policy are also worth discussing further. Another round of political agita could be looming. In January, Republican House Speaker Mike Johnson faces pressure to pass new legislation to keep the federal government funded. It was this issue that brought the Republican Party's far right into a clash with then-speaker Kevin McCarthy leading to his ouster. Another factor is that Speaker Johnson, himself a staunch conservative, could use the issue to provoke a government shutdown to force Biden into agreeing to more spending cuts, something the President would be loath to do as it is an election year, and both parties need to play to their voters.
Related to the potential for a government shutdown is the status of the U.S. sovereign ratings, in particular with Moody's, which is the only major rating agency that maintains an Aaa. This rating is questionable considering the erosion of the broad political class consensus on economic policy, the rise of factionalism in both parties and massive debt buildup. While the U.S. dollar still gives the U.S. government the option to keep printing money (done liberally through the Trump and Biden years) that is not good policy.
Take away the fig leaf of the U.S. dollar (which is being used less than before in international circles), Moody's Aaa is out of place, especially as U.S. debt/GDP ratio is increasingly similar to Japan's, Greece's and Italy's, the world's top three sovereign debtors, each of which have considerably lower ratings. In its August 2023 downgrade Fitch observed that their action "reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance in repeated debt limit standoffs and last-minute resolutions." Can Moody's remain unfazed by the drop in U.S. creditworthiness?
Last, but hardly least of potential problems for the U.S. economy are external geopolitical factors. Among these we would include an escalatory spiral in the Middle East, a widening or intensification of the Russo-Ukrainian War; a further erosion of Chinese-U.S. relations over Taiwan and the South China Sea; and a land grab by Venezuela which claims two-thirds of its neighbor Guyana (one of the world's largest oil producers). And then there are the problems with three major chokepoints in global trade. The Panama Canal has been plagued by a drought which has reduced the number of ships seeking passage from the Pacific to the Caribbean and Atlantic Ocean. The Suez Canal (a critical access point between the Red Sea and Mediterranean) and Bab-el-Mandeb (which separates the Red Sea and Indian Ocean) are seeing a reduction in ships transiting due to the Houthis in Yemen (an ally of Iran) attacking shipping. If this persists there could be an inflationary impact due to higher shipping costs and the potential for oil price pressures. In turn, this could complicate the Fed's mission to reach the 2.0% inflation target.
We would be remiss if we did not comment on the country's mood. Considering the many variables facing the economy, some of which directly impact people's daily life (like higher food prices and the lack of affordable housing), there is a sense of intense frustration with the status quo. Add in the lengthening shadow of AI (and its potential to eliminate jobs) and out-of-control migration into the U.S., there is greater uncertainty than certainty as to how people perceive where the U.S. economy and society are heading. When questioned in a Gallup Poll in November 2023, 80% of Americans said that they were dissatisfied with the way things are going. If nothing else, American angst in 2024 will continue to bundle, stoked by the country's political polarization; its real impact on the economy may become more manifest in the aftermath of the November 2024 elections.
Looking ahead, the U.S. economy is likely to continue its expansion through 2024, though the pace will slow. While there are many things that can go wrong, upside is also possible, especially if external factors are muted, greater investment in M&A is stimulated by stability in corporate earnings and destructive political infighting in Washington is averted (at least until November). We expect that the presidential election will be filled with invective and could have some unexpected chills and spills. However, the strength and resilience that have propelled the U.S. economy through what has been a rolling recovery in 2022 and 2023 are likely to prevail through 2024. For policy planners and market participants, the words of Winston Churchill are worth heeding, "Let our advance worrying become advance thinking and planning."
