• The U.S. economy has remained resilient in the face of moderately restrictive monetary policy. We expect this to remain the case in the second half of the year.
  • Lower inflation readings and a rebalanced labor market set the stage for a recalibration of monetary policy, beginning in September.
  • This recalibration can pave the way for an extended economic expansion. However, uncertainty regarding the presidential election and implementation of former President Trump’s policy platform adds an extra degree of uncertainty to the medium-term outlook
     

One of the more notable aspects of the global economy over the past few years has been the widening gulf in economic performance between the United States and many of its developed market peers. The comparison is not necessarily “apples-to-apples”. Countries have different rates of trend growth, different monetary and fiscal policy stances, and face different exogenous shocks. Most notably, Russia’s invasion of Ukraine led to a pronounced energy and confidence shock in many European countries, dampening growth in 2022 and into 2023. But at the very least, continued solid economic performance in the United States indicates a high degree of resilience to monetary tightening.

 

Figure 1: Level of Real GDP | Indexed to 100 at end-2019

Source: Bloomberg, MacKay Shields. US real GDP through Q2, for all others Q2 value is based on Blomberg consensus forecasts as of July 19

We wrote extensively on this topic in our last quarterly commentary and continue to see evidence that a number of resiliencies, including locked-in low mortgage rates and fiscal incentives for investment, remain supportive of the economic outlook. One conclusion from that analysis was that the economy may be able to sustain a rate of growth at or above two percent over the remainder of the year, even as the pace of growth steps down somewhat from 2023. Recent data have conformed to our expectations. Importantly, a still-strong labor market along with wealth effects from gains on financial assets continues to support solid household spending. In fact, the second quarter saw a stronger contribution to GDP from household spending compared to the prior quarter.

While our overall views have not changed, we are struck by the extent to which sharp increases in immigration have impacted overall economic activity, the labor market and potentially even inflation. First and foremost, high levels of immigration not only increase household spending, but have also boosted the trend rate of growth in the economy through its effect on the size of the labor force. Along with anticipated monetary easing, this remains a primary reason why we see the economy sustaining a solid pace of expansion.

 

Figure 2: Revision to Trend Growth Estimates Resulting from Higher Immigration

Source: Congressional Budget Office, MacKay Shields. Revision based on CBO's February 2024 projection vs. projection one year earlier. www.cbo.gov/publication/59710

The immigration-backed increase in labor supply has occurred over a period of time when marginal labor demand has moderated, as evidenced by the steady decline in job openings over the past two years. As a result, the labor market is much closer to balance and should no longer be a source of meaningful inflationary pressures. For example, our labor market conditions index, which draws on a range of labor indicators from the Bureau of Labor Statistics and household and business surveys, has returned to levels seen in 2019 – certainly not a period associated with too-rapid wage growth and high inflation. The labor market remains strong, but is no longer tight.

 

Figure 3: Labor Market Conditions Index

Source: MacKay Shields, based on data from the Bureau of Labor Statistics, Department of Labor, National Federation of Independent Businesses, Institute for Supply Management, and Conference Board

The rebalancing of the labor market and moderation in inflation sets the stage for a sustained recalibration of monetary policy as the FOMC turns its attention to extending the economic expansion. However, there is a large degree of uncertainty surrounding our medium-term economic and monetary policy outlook as we head into a consequential election cycle that has the potential to reshape domestic economic policy as well as foreign policy. At time of writing former president Donald Trump maintains a lead in polls over Vice President Harris, including in many electoral swing states, and prediction markets currently assign about 60 percent odds of him returning to the White House. In looking through his agenda, we are struck by the mix of inflationary policies, including tariffs, immigration restrictions and deportations and expansionary fiscal policy. The growth implications however are much more mixed. Further corporate tax cuts and deregulation would support growth, but immigration restrictions and tariffs (and retaliation by trading partners) decidedly push in the opposite direction. The outlook for Congressional elections, as well as questions about which aspects of his election platform Trump will carry out in full, add additional uncertainty. As such, even as the data in hand increasingly support prospects for policy easing and an extended economic expansion, the election and an uncertain policy agenda will require an added level of vigilance and nimbleness on the part of investors.

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