The downshift in U.S. growth we anticipated in our last quarterly has now materialized. After expanding at a 4.1 percent annualized rate in the second half of last year, GDP is tracking at around a 2.25 percent growth rate for the first quarter of 2024.
Still, growth at or above two percent now looks sustainable over the coming quarters. While the policy rate appears restrictive, broad financial conditions tell a different story. With sharp gains in equities, a tightening in credit spreads and Treasury and primary mortgage rates well off the highs of last fall, financial conditions are now providing a modest tailwind to growth.
Easing financial conditions despite an elevated policy rate is less a conundrum than it appears at first blush. One explanation, which we find increasingly compelling, is that a number of resiliencies are serving to offset the impact of monetary tightening. In the household sector, these include locked-in household borrowing costs, elevated levels of aggregate net worth and a return to moderate real wage growth as inflation subsides.
Figure 1: Financial Conditions Have Become a Modest Growth Tailwind
Data as of February 1, 2024
Source: Board of Governors of the Federal Reserve System.
Resiliencies also extend beyond the household sector. Fiscal incentives in the CHIPS Act, Inflation Reduction Act and the bipartisan infrastructure deal are supporting investment spending by business as well as state and local governments. And finally, despite its contentious political and social ramifications, a sharp increase in immigration is boosting aggregate demand and allowing for a higher level of sustainable payrolls growth. Individually, these resiliencies may be modest, but collectively they can amount to a meaningful tailwind to growth. And while some resiliencies are continuing to fade, for the foreseeable future they can bolster the economy and build a bridge to an eventual easing in monetary policy.
Beyond resiliencies, patterns of sectoral activity also support a constructive outlook for the economy. The housing market experienced a meaningful contraction in 2022 and through the first half of last year, as developers, buyers and sellers adjusted to higher interest rates.
Figure 2: A Return to Real Wage Growth as Inflation has Moderated
Data as of January 31, 2024
Source: Bureau of Labor Statistics, Federal Reserve Bank of Atlanta
But judging from housing starts, as well as new and existing home sales, the worst of this adjustment appears to be in the rear view mirror. Elsewhere, the corporate sector has emerged from a modest profit recession, and wide margins set the stage for healthy levels of capital expenditure and hiring. Similarly, judging by new orders data, the manufacturing sector also appears to be stabilizing after a period of weakness, and should be further supported this year by an upturn in the inventory cycle.
Even as we see better prospects for a sustained period of solid performance for the U.S. economy, the outlook is not without risks. Most notably, inflation readings have been firmer than anticipated since the start of the year, and suggest a non-negligible risk that progress towards the two percent inflation objective could stall. Durable goods deflation, an important contributor to the moderation of inflation in the second half of last year, may have run its course. The recent upturn in global manufacturing activity, as indicated by the new orders index of the global manufacturing PMI, has been accompanied by a firming in both input and output prices. Meanwhile, a solid labor market alongside high levels of net worth have slowed progress on services disinflation.
Figure 3: Global Manufacturing PMI: Improving New Orders Comes with Price Pressures
Data as of February 29, 2024
Readings above (below) 50 indicate expansion/increase (contraction/decline).
Source: S&P Global
These recent inflation developments pose challenges for policy makers. Progress on bringing down inflation over the past year, alongside a modest rise in the unemployment rate, suggest the time is approaching to cut rates. A range of Taylor rule prescriptions indicate as much (see chart below). But the firming in inflation to start the year has left FOMC participants sounding increasingly cautious on rate cuts, especially as strong economic performance provides the flexibility to be patient. At this point, we expect policy easing to be pushed out towards the end of the year. Nevertheless, if delayed policy easing comes alongside still-firm growth, we believe the environment will remain constructive for credit.
Figure 4: Taylor Rules Indicate that Easing is Appropriate
Data as of February 1, 2024
The five monetary policy rules used in this analysis are the original 1993 Taylor Rule, a balanced-approach rule with and without inertia, a balanced-approach shortfalls rule, and a first-difference rule.
Source: MacKay Shields, Board of Governors of the Federal Reserve System, Bureau of Economic Analysis
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