As we approach the New Year there are all manner of traditions. Some are more fun than others. The economists of the world are called upon to make predictions and forecasts as if the passing of an old year into a new one actually mattered to the drivers of the economy but it is tradition and who am I to argue? This is what I see ahead in four key economic areas.
Number One: Interest Rate Policy – The Federal Reserve has been chanting the mantra of “higher for longer” through the majority of the last several months and that will be their position through at least the first half of 2024. It is true that inflation has dipped a little (more about that in the next paragraph) but it is still well above the ideal level set by the Fed. The central bank mantra is that they raise rates until they break something and then they set about lowering rates to fix what they broke. The prime indicator of whether they have broken enough is unemployment. When that rate goes up the assertion is that the economy has been slowed enough. Right now, the U-6 rate is as low as it has been in years. The Bureau of Labor Statistics releases six cuts of their data and U-6 is the most complete as it picks up the discouraged worker and the involuntary part time worker. It is sitting at 6.7% and the long-term average is 10.1. As long as that rate is this low the Fed will have room to raise rates if they deem it necessary. Beyond that, there is the fact the economy was growing at 5.2% in the third quarter and Q4 is expected to be at 2.3%. These are not numbers that suggest imminent recession and therefore the Fed is not feeling intense pressure. It seems likely that rates will start to decline slowly by the middle of the year – maybe three or four quarter point cuts by the end of 2024.
Number Two: Inflation – There are some interesting theoretical conversations taking place that could affect the reaction of the Fed to inflation. It has been assumed for years that the “neutral” Fed Funds rate is 1.0% and that is what prompts the Fed to set its inflation target at 2.0%. There is mounting evidence suggesting the neutral rate might be 2.0% or even 2.5%. The neural rate means that anything over that rate slows the economy and anything under those levels stimulates. If the neutral rate is higher than assumed, the Fed could shift its inflation goal to 3.0%. Right now, the inflation rate as measured by Personal Consumption Expenditures is just slightly over 3.0 (at the six-month level as of September). It is close to 4.0% on an annual basis and core rates rose a little in the last month. Th drivers of inflation now are housing and wages and both of these will be factors next year as well. The factors that have lowered inflation threats have been energy and food. Neither of these are counted in figuring core inflation rates as these are intensely volatile. Inflation will keep falling next year but any shift in energy or food will drive prices back up in a hurry.
Number Three: Threat of Recession – Economists have been predicting recession for the last five quarters and have yet to be on target. In Q3 of this year the assumption was a decline of over 1.0% and what we actually got was growth of 5.2% Now we have economists predicting a shallow recession at the start of 2024 (negative 1.0% in Q1 and negative 0.7% in Q2). But that is hardly a universal opinion as many have watched these dire predictions fail. The more optimistic assessment is growth around 2.0% (close to the twenty-year average of 2.5%). The two factors that have kept us out of a downturn thus far have been consumer spending and inventory build. If the consumer starts to falter under that $1.8 trillion credit card debt and the $17 trillion overall debt their contribution could falter fast. If business stops inventory accumulation the economy also starts to retreat. At the moment there is not a lot pointing to an imminent recession as corporate investment remains robust and other growth indicators are positive.
Number Four: Unemployment and Worker Shortage – The jobless numbers are historically low and there have been job gains every month despite the predictions of decline. The U-6 rate is as low as it has been in years and the U-3 rate is still well under 4.0% (remember when 6.0% was considered low). The very low rates have been propelling wage inflation and the fact is that worker shortage will dominate next year and for many years to come. The quit rate is as high as it has been in years. Lately there have been some high-profile layoffs but in general the job market remains extremely tight.
