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[...]Dr. Ray Perryman of the Perryman Group states that the economy has slowed modestly but remains remarkably resilient while inflation has continued to moderate. According to Consensus, the ratio of Personal Consumption Expenditures over Personal Disposable Income is predicted to stay put at 92.00% through the first quarter of 2024 and then slightly decline to 91.00% during the second and third quarters of 2024. According to Dhawan, national job growth will turn mildly negative by the first half of 2024 at 68,000 monthly losses, rebounding to 75,000 job gains by mid-2025 as Fed rate cuts spur investment spending. [...]Wells Fargo has modestly boosted their forecast for single-family starts over the next two years to reflect the stronger demand environment.
Unemployment continues to stay at historic low levels (3.80% in Aug) despite the slight increase from its July level of 3.50% and the Fed's aggressive efforts to bring inflation (3.00% in June) back to prepandemic levels. Hence, Dr. Ray Perryman of the Perryman Group states that the economy has slowed modestly but remains remarkably resilient while inflation has continued to moderate. Similarly, Wells Fargo believes that despite the 525 bps of Fed rate hikes since March 2022, recent data indicate that the US Economy remains strong.
However, according to Rajeev Dhawan of the Economic Forecasting Center at Georgia State University, job compressions in sectors ranging from corporate to transportation are resulting in fewer homeowners moving up to bigger and better jobs combined with a reluctance to take on higher-rate mortgages, putting the nation in a white-collar, middle class, middle-management 'recession.' Dhawan adds that this is not a recession in the traditional sense because job creation is continuing in the healthcare, hospitality, and construction sectors. He is concerned that high-paying job growth has completely stalled and wonders if Fed rate cuts would have the intended effect of positively impacting economic growth. Further, Dhawan predicts that U.S. GDP growth will moderate sharply from the expected 2.3 percent in the third quarter of 2023 to less than 0.5 percent in the first half of 2024.
Consensus expects the nation's GDP growth rate to increase by 0.61% during the period from Q4 of 2023 into Q3 of 2024. This would be a meek increase which could result in a slowdown of economic activity across the nation. At the same time, Consensus predicts M2 money supply (in July at $20,902.70b) to grow at a rate of 3.38% during that same period, from Q4 of 2023 to Q3 of 2024, which may push inflation up, reduce consumer purchasing power, and affect economic growth.
CONSUMERS: AMERICANS HAVE CASH BUT ARE CAUTIOUS; SPENDING TO CONTRACT IN 2024
Going forward, during 2023 and into 2024, Consensus expects the change in the personal disposable income to be 3.73% from Q4-2023 to Q3-2024 while personal consumption expenditures is forecasted to increase by 2.98% during that same timeframe. This indicates that consumers continue to keep their expenditures below their disposable income in anticipation of uncertainty in the economy. However, there has also been an increase in credit card utilization. Correspondingly, Wells Fargo notes that consumers have increasingly relied on income to spend, though excess savings and borrowing are still factors helping to support purchases. They further add that the resumption of student loan payments after a more than three-year pause is set to start again toward the end of September, which could crimp spending by about a half percentage point but is likely not enough to cause broad contraction. Overall, they look for consumer spending to slowly moderate in 2023 before contracting in early 2024 amid a greater deterioration in the labor market.
According to Consensus, the ratio of Personal Consumption Expenditures over Personal Disposable Income is predicted to stay put at 92.00% through the first quarter of 2024 and then slightly decline to 91.00% during the second and third quarters of 2024. Similarly, Wells Fargo states that real personal consumption expenditures (PCE) rose at a 1.60 % annualized pace in Q2 of 2023. While that still marks a solid pace of expansion, it's less than half the pace at which PCE expanded in Q1 of 2023 and points to the fact that while spending remains resilient, it is not without signs of a slowdown. Further, Wells Fargo looks for the year-over-year rate of core PCE inflation to register 3.50% in the fourth quarter of 2023. Dhawan expects CPI inflation to moderate to 2.70% in 2024. He suggests that core inflation-after averaging 4.90% in 2023-will steadily climb down to 2.40% in 2024.
Consensus expects light vehicle purchases to increase by 2.77% from the fourth quarter of 2023 into the third quarter of 2024 with sales reaching 15.52 million units in Q3 of 2024. This indicates consumers will continue replacing their vehicles. Dhawan believes that there is a lot of pent-up demand for domestic travel by car and by air, and that's not going away anytime soon. This demand combined with OPEC whittling its oil supply, has pushed up the price of oil by $15 (crude oil at $87.23 in September) per barrel recently.
Chained Price Index growth is expected to be at 1.83%, which is the same as the growth of the Consumer Price Index of 1.83% for the Consensus period. (The chained price index is a measure of price levels of consumer goods and services based on consumers' behavior of substituting products with less expensive ones in an inflationary environment.) This, on the other hand, indicates that consumers are being very cautious with their spending.
FIRMS: MIDDLE MANAGEMENT TAKES A BEATING, CONSTRUCTION TO EXPAND IN 2024 AS MORTGAGE RATES SET TO FALL
Consensus expects the unemployment rate (3.80% in Aug) to increase from the projected 3.75% level in the fourth quarter of 2023 to a level of 4.22% in the third quarter of 2024, whereas Wells Fargo expects a push up in the U.S. unemployment rate from its 3.50% level in July 2023 to a peak of 4.60% in the second half of 2024. Their projections are significantly higher than Consensus. That said, Wells Fargo believes the weight of the evidence still suggests that the labor market remains too tight to be consistent with the Fed's desired 2% inflation, and they expect more softening in the labor market in the months ahead. Dhawan believes the most impacted employees are middle management, a trend that began during COVID lockdowns as businesses realized technology made it possible to run operations remotely without many supervisors. Those jobs are not coming back. According to Dhawan, national job growth will turn mildly negative by the first half of 2024 at 68,000 monthly losses, rebounding to 75,000 job gains by mid-2025 as Fed rate cuts spur investment spending.
In terms of residential construction, Wells Fargo indicates that the recent rebound in residential spending has been largely fueled by strengthening of single-family activity. As of June of 2023, new home sales were up nearly 24% on a year-over-year basis. Consequently, builder sentiment has brightened. As new home sales have trended higher, builders look to be scaling up production to meet demand. Hence, Wells Fargo has modestly boosted their forecast for single-family starts over the next two years to reflect the stronger demand environment. Dhawan expects the 30-year mortgage rate to average around 6.60 percent in 2023, then moderate sharply to 5.70 percent in 2024. (Average interest rates in September for fixed-rate mortgages were around 7.12% for the 30-year and 6.52% for the 15-year).
Consensus expects the Private Housing Starts to be at 1.36 million units during the fourth quarter of 2023, then to drop to 1.34 million units during the first quarter of 2024, and then to increase to 1.40 million units during the third quarter of 2024. This will cause slight volatility in the construction industry early in 2024 while improving later and impacting unemployment and economic growth positively.
Industrial Capacity Utilization is expected to decrease slightly from its fourth quarter 2023 level of 78.39% to 78.36% in Q3 of 2024, which is a slim decrease of -0.03% during the consensus period. Consensus expects non-residential fixed investment to increase slightly by 0.32% from Q4 2023 to Q3 of 2024, while Wells Fargo continues to foresee a tighter credit condition for nonresidential structure investment throughout the forecast horizon.
INTEREST, CREDIT, AND THE FED: AGGRESSIVE RATE CUTS IN 2024 COULD SURPRISE MANY
According to Consensus, the triple "A" quality corporate bond rate (4.87% in Aug) is expected to decline from 4.95% in the fourth quarter of 2023 to 4.71% in the third quarter of 2024. For the 10-year Treasury yield, Wells Fargo expects a steeper curve and lower Treasury yield later in 2023 and into 2024 and the target at year-end 2023 and 2024 is to be 3.70% and 3.15% respectively.
The Consensus forecast for the Federal Funds rate is to decrease from 5.49% in the fourth quarter of 2023 to 4.73% in Q3 of 2024. This would help boost economic growth. Wells Fargo expects no additional rate hikes from the FOMC, with the first-rate cuts occurring in Q2-2024 as the U.S. economy falls into a mild recession and core inflation is much closer to 2%. They expect quantitative tightening to continue until the end of Q1-2024. After that, they look for the FOMC to keep the size of its balance sheet flat as it enters a rate-cutting cycle. Correspondingly, Dhawan believes that the Fed is done with raising rates and beginning in spring 2024, when the economy starts to flag, the Fed will come out with rate cuts and people will be surprised by their aggressive pace.
Despite the remarkable strength in manufacturing outlays, according to Wells Fargo growth in overall spending appears to weaken against a backdrop of higher financing costs, reduced credit access and deteriorating commercial real estate fundamentals. Accordingly, they see commercial real estate to continue to be challenged by higher interest rates (which means new construction is likely to downshift over the next several years). Furthermore, oil and gas rig counts continue to decline, with the downdraft implying less spending on oil and gas projects moving forward.
Dr. Perryman indicates that there are some notable risks, such as the real estate loan portfolios of numerous substantial financial institutions but barring any major jolts (such as an extended auto strike or a major COVID resurgence) the economy should be able to sustain positive growth.
CONCLUSION: GLOBAL ECONOMY STABLE DESPITE HEADWINDS, EXPECT FED RATES CUTS, US DEBT CONCERNS INCREASE
The US trade deficit widened (2.00% or $65b) by less than expected in July meaning that trade could be a boost to growth in the July-September quarter of 2023. Exports rose 1.60% to $251.70 billion in July. This is the first gain in exports after three straight monthly declines. Imports jumped 1.70% to $316.70 billion. This is the third monthly increase in imports this year. US employers added 185,000 more workers to nonfarm payrolls in August bringing unemployment to 3.80%. This continues to be a very low rate, yet it has gone up from its previous level of 3.50% in July. The Fed hiked interest rates by 25 bps at its July 2023 FOMC meeting, continuing an aggressive campaign of nearly one dozen rate hikes, intended to damp rising inflation. As the US inflation is at 3.30% in July, very likely the Federal Reserve will pause interest rate hikes in its September FOMC meeting. This would mean that they will continue to watch inflation closely while sustaining economic growth to stimulate demand for housing, encouraging construction of more units and thereby monitoring unemployment. Dr. Perryman states that the prospects for improving price stability while avoiding a recession continue to improve.
For the US economy, Wells Fargo expects a federal budget deficit of $1.80 trillion in fiscal year (FY) 2023, excluding any student loan forgiveness accounting adjustments. For FY 2024, they look for a federal budget deficit of $1.85 trillion. In the meantime US debt continues to rise, creating concerns.
As far as the global economy, Wells Fargo expects it to grow at 2.70% in 2023 before decelerating slightly to 2.50% in 2024. With Chinese authorities taking a cautious approach toward monetary easing and with no signs of large-scale fiscal stimulus yet, Wells Fargo has lowered their 2023 China GDP growth forecast to 5.20%, from 5.70% previously. However, they believe economic activity has been reasonably solid in both the United States and Mexico during the first half of 2023 to lift their 2023 GDP growth forecasts to 2.10% and 2.90%, respectively, while they have also revised their Eurozone GDP growth forecast slightly higher and they believe the July rate hikes delivered by ECB and the Bank of Canada will prove to be the last of the current cycle.
According to Dhawan, multiple factors are contributing to sputtering global economic growth, namely China is not yet firing on all burners, which is holding down the rest of Asia; the Ukrainian-Russian conflict is casting a dark shadow over European growth, and Latin America economies are not performing well due to factors including bad debt, currency mismanagement, and a lack of commodity demand from China.
Wells Fargo forecasts the trade-weighted dollar to remain steady to perhaps slightly stronger through the rest of 2023, before falling around 4.00% during 2024. That said, if the balance of risks continues to shift toward a shallower (or no) U.S. recession, and less aggressive Fed rate cuts, it is possible the U.S. dollar's decline might be less pronounced than they currently anticipate.
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Copyright Journal of Business Forecasting Fall 2023