Washington reached a deal in early June suspending the debt ceiling for two years and eliminating the risk of crisis from a federal default. The deficit is still an issue: The Congressional Budget Office forecasts it to exceed 5% of GDP for the next few years, meaning the federal debt would continue to grow faster than the economy. Rising debt and interest rates will raise the government’s interest expenses, keeping DC under pressure to further narrow the gap between revenues and spending in the next few years.
Recent data and revisions show the economy had better momentum in the first half of 2023 than previously believed. Real GDP in the first quarter was revised up to 2.0% at a seasonally-adjusted annualized rate in the third estimate from 1.3% in the prior release and 1.1% in the first estimate.
Details were stronger, too. Real final sales to private domestic purchasers—a measure of core GDP that leaves out components disconnected from the underlying trend like inventory fluctuations, foreign trade and government spending—was revised up to a solid 3.2% annualized increase from 2.9% previously. Post-revisions, GDP is more consistent with the 312,000 jobs added per month in the payroll survey, a pace that held steady in April and May. Jobless claims indicate the job market softened a bit in the second quarter, with both initial and continued claims up from the turn of the year.
Even so, the economy has done better than expected so far in 2023. Comerica’s June forecast revises up the forecast for 2023’s real GDP growth to 1.3% from 0.9% in the May forecast, with growth expected to slow to 0.5% in 2024 as the long and variable effects of the Fed’s tighter monetary policy weigh on interest-rate sensitive economic activity.
Inflation is slowing, although by how much depends on how it’s measured. The glass-half-full view is that most prices in the consumer basket have cooled dramatically aside from the shelter component. And CPI-Shelter should slow in the next few quarters as well, since it predictably follows house price indexes and rents on new leases, both of which have cooled this year.
The glass-half-empty view (The view that more accurately described inflation dynamics since the pandemic) is that aside from energy prices, inflation is still far above normal. Furthermore, house prices are stabilizing despite high interest rates, creating upside risk to shelter inflation in 2024 and 2025. Inflation of other labor-intensive services is running faster than total CPI, too, another upside risk to the inflation outlook.
With a decent growth picture, inflation too high, and difficulty judging how much the trend is slowing, the Fed will likely raise the federal funds rate a quarter percentage point at the July 26 decision to a range of 5.25%-to-5.50%, then hold it unchanged until a first cut in March 2024. If growth or inflation keep coming in above expectations, the Fed could make another quarter percentage point hike between the July decision and the end of 2023.
Bill Adams is a senior vice president and chief economist at Comerica. Waran Bhahirethan is a vice president and senior economist at Comerica.
