Consumer sentiment rebounded to the highest since mid-2021 in January, and stock market indexes rose to new record highs, cheered by a steady flow of good news about the economic outlook. Real GDP growth is slowing from the third quarter of 2023’s unsustainably fast 4.9% annualized increase.
But the odds of a recession in the year ahead look considerably lower than they seemed in early 2023. Household incomes are outpacing inflation, mortgage rates and rates for other types of longer-term borrowings are down from peaks in October, and domestic energy production is growing much faster than GDP, a boost to the supply side of the economy and competitiveness.
While some measures of inflation edged higher in year-over-year terms in late 2023, that was largely due to wonky base comparisons against late 2022, when a sharp drop in prices of gasoline and other energy products briefly tempered inflation. One tool to look through this volatility is the six-month annualized rate of inflation, which continued to slow in late 2023.
In fact, by the Fed’s preferred measure, both total and core inflation were already back to the central bank’s target in six-month annualized terms in November (Chart below). With the labor shortage abating, house price increases coming in line with the pre-pandemic pace, and new residential leases flat to lower across much of the country, core inflation is likely to cool further in year-over-year terms in the first half of 2024.
The Fed’s rate setting committee agreed in December that “some time” should pass before they would be ready to start reducing interest rates, and communicated that message in the meeting’s minutes, which they released in January. How much time? Financial markets are positioned for roughly coin-toss odds of the Fed cutting rates in March, interpreting recent inflation releases as signs that inflation is “clearly moving down sustainably” toward the Fed’s target, their precondition for cuts.
Comerica sees the Fed as more likely to wait until June before cautiously beginning to reduce rates, and making quarter-percentage-point cuts in that month, September, and December. The Fed is also likely to slow the pace of its balance sheet reductions in the second half of 2024, and end them in late 2024 or the first half of 2025, which could provide a further boost to financial market sentiment.
The key risks to this outlook are upside risks to inflation: Internationally, from wars in the Middle East and Ukraine that could disrupt energy supplies and trade flows; domestically, from wage growth that could outpace productivity and inflame wage-price pressures; or in Washington, where a wave of Treasury issuance last fall likely contributed to a (thankfully short-lived) jump in market-determined long-term interest rates. Even so, 2024 will likely mark a normalization of the U.S. economy, with growth, inflation, the job market, and interest rates looking more and more like they did before 2020.
Bill Adams is a senior vice president and chief economist at Comerica. Waran Bhahirethan is a vice president and senior economist at Comerica.
