A Positive Glidepath for the US Economy
What happened last week?
- The S&P 500 gained 0.21%
- The Dow Jones stood still at 0.01%
- The Nasdaq advanced 0.69%
Fed rate cut expectations in 2024 were trimmed on Friday when data showed the unemployment rate for November dropped to 3.7% and the economy added 199K jobs.
The market is now discounting slightly less than 50/50 odds of a first rate cut in March versus above that level the day before the report was released. The job growth was less strong than it seemed at first glance because a lot of it was fueled by returning strikers and government hiring.
Plus, the total over the two prior months was revised -35K lower.
The S&P 500 is just 4.0% below its all-time high.
3 Things to Know
2024 Is an Important Transition Year and Data Is Supportive
We see 2024 as an important transition year that sets the stage for more sustainable rates of growth and market returns ahead. Though growth is likely to slow in early 2024, we see no synchronized collapse across the global economy, as many fear.
The latter half of 2024 should show a return to sustainable economic momentum as well as an improvement in corporate earnings. We anticipate global economic growth to strengthen in 2025.
This should become apparent to investors as earnings estimates for 2025 rise. We expect a 12% increase in earnings per share (EPS) over the next two years.
Last week’s data showed a solid US employment gain of 199,000 in November. This followed a very bullish run of inflation data that had dropped US 10-year note yields as much as 90 basis points.
This employment report underscores the US economic resilience we discuss in our Wealth Outlook 2024. Despite the fastest rate hiking since the Fed started announcing targets the US economy has been remarkably resilient.
There have been several reasons for this. The bulk of the initial recovery from the pandemic was built on fiscal stimulus. During this time, the private sector did not “overbuild.” It “under-hired.” Subsequently, as stimulus was reduced, there was strong pent-up demand, particularly for services labor.
While inflation harms incomes, receding inflation is reducing this harm. In our Wealth Outlook 2024, we argue that “rolling recessions” have impacted cyclical industries and corporate profits over the past year.
Rolling areas of weakness will continue, but all are likely to “roll out” within the year to come.
In 2024, we expect falling inflation and a turn in Fed policy will set the stage for an improved market environment that will anticipate faster growth later in 2024.
Timing of the Fed Pivot
The Fed is going to wait until the labor market cools before it begins to make meaningful rate cuts. The fact that core inflation surged and fell over the past two years due to supply and demand imbalances, as well as much higher ambient interest rates, is its primary concern for now.
We expect the US Federal Reserve to lower rates at the short end as it sees employment harmed by the lagged effects of its tightening actions.
If unemployment rises more quickly than expected, the Fed will also react faster by lowering rates more quickly. Labor demand has done nothing but grow in the past few years, though that demand is slowing.
But wages have not been a major inflation driver relative to supply chain pressures. Core inflation has diminished in 2022-2023 without an outright loss in employment.
We see there has been no correlation between the unemployment rate and the rate of inflation over the past couple of years, using the Fed’s preferred measure, suggesting the Fed does not need to sacrifice the economy.
Markets Responding Positively to Fed’s Likely Inflation Path
We see inflation running at 2.5% by the end of 2024 with 10-year rates in a range between 3.5% to 4.0% at that time. Following this period of falling inflation and rates, we expect the growth rate of production and capital investment to improve and consumer spending to firm heading into 2025.
When supply and demand meet at a high level as inflation is falling, there is no need to crush the economy and labor markets to bring down inflation.
The Fed will likely make this observation and it is one of the key reasons why financial markets have responded positively to reports showing inflation is slowing over the past few months.
But we have little doubt that US employment gains will continue to slow. While there were some strong segment gains in November, only 52% of private industries — barely a majority — added headcount.
As of October, the level of unfilled job openings has fallen by 3.3 million after peaking in March 2022. As we note in our Wealth Outlook 2024, some new supply shock remains among the biggest potential “spoilers” for our base case. When supply shocks have occurred — the most acute of which were seen in 2020, at the start of the 1970s, and the start of the 1980s — higher prices coincided with weak labor markets.
But barring some loss of supply, we believe greater equilibrium between supply and demand is being restored in the world economy, and that’s good news for all.
See our weekly CIO Strategy Bulletin for more details