Macro Signposts | 22 May 2024
Unless explicitly stated, views expressed do not constitute official PIMCO views.
Above-Target Inflation and Slowing Growth: U.S. Outlook for 2024
Although the Federal Reserve probably won't hike interest rates again this cycle, it may not be quick to cut, either: That's our conclusion based on the latest inflation data and on important trends underlying U.S. growth.
Last week, the markets' immediate enthusiasm following the April U.S. consumer price index (CPI) report likely reflected relief that inflation did not surprise to the upside, making the already only modest chance of rate hikes seem even more modest. However, U.S. inflation remains stubbornly above the Fed's target of 2% (as measured by core PCE – personal consumption expenditures).
It would take a notable downshift for inflation to move sustainably closer to that target. After April's CPI and PPI (producer price index) reports, we estimate core PCE inflation to be around 0.25% for the month of April, and 2.8% measured over the past year. If our April forecast is right, core PCE inflation will need to average 0.20% per month for the rest of 2024 (versus the 0.33% average monthly measure for the first four months of the year) for the overall annual rate to land at 3%.
The Fed may be willing to tolerate some above-target inflation for a period of time, provided the direction of travel seems clear. However, this doesn't mean the Fed will be quick to cut interest rates. Indeed, the optics of cutting when the year-over-year rate of inflation is around 3% are difficult, in our view. (For details, please read "April Inflation Report Unlikely to Alter Fed's Path.")
Expect changes in the Fed's macro projections
Given the trends in the data, we expect Fed officials to make substantial revisions to their forecasts when they release the new Summary of Economic Projections in June. We expect they will revise up their inflation projections, and (as we suggested in our 11 April 2024 Macro Signposts) revise their median rate projections to guide toward a later start to rate cuts: perhaps December or possibly even later. Federal Reserve Board Governor Christopher Waller echoed this sentiment during comments to the media on Tuesday, saying, "and if the data were to continue softening over the next three to five months, you could think about doing it [cutting rates] towards the end of this year."
Signs of slowing growth
Despite our view that U.S. inflation will remain sticky, we still believe real GDP growth, which has averaged a solid 3% pace over the last three quarters, will slow in the second half of 2024 for two reasons.
First, immigration into the U.S. has markedly slowed since the turn of the year, according to data from U.S. Customs and Border Protection. Seasonally, immigration tends to drop in the month of January, but the absence of reacceleration since then suggests that the additional funding the Biden administration reportedly provided to Mexico to police their own border may be limiting entries into the U.S. While there are obvious political implications, from a purely economic perspective, we estimate – admittedly with wide uncertainty bands – that the drop in immigration could contribute to a 50 to 100 basis point (bp) slowdown in GDP growth in 2024.
Second, government spending – including state and local spending – is also slowing from the strong pace that was driven by pandemic-related programs. State and local spending contributed a little over 50 bps to U.S. GDP growth last year, while federal spending contributed around 20 bps. Although federal infrastructure funding to the states should continue to support state and local spending, we expect the overall contribution to real GDP in the second half of 2024 to be about half of the 2023 level.
Against those two trends, capital expenditures (capex) look poised to recover somewhat as real corporate profits (as measured by the national income and product accounts) accelerate, and credit conditions stop tightening. Middle- to higher-income U.S. consumers, who tend to be still flush with cash and wealth, are supporting overall domestic demand and are also supporting jobs for lower-income consumers. This trend will likely continue as consumers, with generally healthy balance sheets, should have room to increase their personal leverage.
Takeaways
Where does that leave us? U.S. growth appears to be slowing from an elevated 3% level to closer to its 2% longer-term trend, while core inflation appears stuck around 3%, and the unemployment rate has been moving sideways at around 4%.
While Fed officials may not be hiking in this type of environment, they probably aren't aggressively cutting either, at least not until they see greater evidence of a more serious U.S. economic downturn.
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