The economy continues to exhibit a remarkable degree of resiliency
|"Passive" tightening of monetary policy to exert increasing headwinds on the economy
We estimate that real GDP grew in excess of 4% at an annualized rate in Q3-2023. Moreover, growth appears to have been broad-based across most components of spending.
Despite the resiliency of the U.S. economy recently, we think the FOMC will not raise its target range for the federal funds rate any higher in this cycle. The FOMC has made considerable progress in returning inflation to its target of 2%.
But we also forecast that the FOMC will refrain from easing policy until it is convinced that inflation is returning to 2% on a sustained basis. Consequently, monetary policy will become increasingly more restrictive on a "passive" basis. That is, the real fed funds rate will move higher in coming months as inflation recedes further while the FOMC remains on hold.
We forecast that the real fed funds rate will rise to roughly 2% by the end of this year, and it will be approaching 3% by mid-2024. The last time that the real fed funds rate exceeded 2% was in 2006-2007, when the potential economic growth rate of the U.S. economy was much stronger than it likely is today.
In our view, this rise in the real fed funds rate will lead to a modest contraction in economic activity in 2024. But our degree of conviction about an outright recession is not as strong today as it was about a year ago when the FOMC was aggressively tightening monetary policy.
We have a stronger conviction that the economy likely will need to grow at a sub-trend rate for a few quarters, if it actually does not contract, to bring inflation back to 2% on a sustained basis. In our view, there is little difference for many businesses and consumers between an economy that is barely growing and one that contracts at a modest rate for a couple of quarters.
The economy continues to exhibit a remarkable degree of resiliency
Recent data indicate that the U.S. economy continues to expand at a solid rate. Real GDP grew at an annualized rate of 2.1% in Q2-2023, and we estimate that this sequential rate of economic growth strengthened to more than 4% in the third quarter. Although the Bureau of Economic Analysis (BEA) will not publish the "advance" estimate of Q3 GDP growth until later this month, the uptick in employment growth—nonfarm payrolls rose at an average monthly rate of 266K in Q3 relative to the average monthly rate of 201K in the second quarter (Figure 1)—is consistent with an acceleration in real GDP. Moreover, the drivers of spending growth appear to have been broad based in the third quarter. Monthly data indicate that real consumer spending grew at a robust annualized clip of nearly 4% in Q3. Although we estimate that real business spending on equipment may have edged down a bit, other areas of investment spending appear to have grown modestly. Real net exports likely made a positive contribution to real GDP growth during the quarter.
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