US - Recession to start in Q4; Fed cuts delayed to March
We now expect a US recession to start in Q4, with Fed cuts also delayed to next March
We now expect a US economic downturn to begin in Q4 2023. We have upgraded our 2023 growth forecast, but significantly downgraded our 2024 forecast
More near-term resilience will now likely mean a later start to interest rate cuts - and therefore a more prolonged period of highly restrictive monetary policy
We now expect the Fed to hike once more in July, and to start cutting rates in March
We now see a recession starting in Q4 this year; previously we expected a downturn to begin in the current quarter. The trigger for our change has been the recent resilience in jobs growth and consumption, which has offset weakness elsewhere (particularly manufacturing and housing). While retail sales have essentially flat-lined in real terms (i.e. after adjusting for inflation) in recent months, this will not be enough to drive an outright decline in private consumption in the current quarter given that services consumption continues to recover from the pandemic (albeit at a modest pace). This is being driven partly by continued strength in consumer credit growth, which for the time being is offsetting the weakness in real incomes and the decline in excess savings. Meanwhile, though cracks in labour market strength have appeared in recent months in the form of rising layoffs, jobs growth in aggregate has remained robust for the time being, reflecting persistent labour supply/demand imbalances and labour hoarding behaviour since the pandemic.
Given that the economy has persistently defied recession expectations so far, it is reasonable to ask whether there will really be a recession at all. We think there will, because we view the drivers of the recent resilience – the strength in both consumer credit and jobs growth – as unsustainable. First, the combination of significantly higher interest rates and much tighter bank lending standards is likely to drive a cooling – and ultimately declines – in consumer credit over the coming months. Second, as consumer demand has cooled, employment growth has considerably outpaced GDP growth in recent quarters, with the result being falling productivity and a jump in unit labour cost growth. For this to continue, businesses would need to accept a sustained fall in profit margins, which we view as unlikely. Indeed, job layoffs have risen recently, it is just that this is being offset for now by strong demand elsewhere in the labour market. It is historically unusual to see such a fall in productivity and a rise in layoffs and for this not to lead to a meaningful rise in unemployment. We therefore think it is a matter of time before job-cutting behaviour spreads more widely, and this should drive a bigger hit to consumption.
Alongside the later recession, we now expect this to mean a later start to Fed rate cuts, leading to a more prolonged period of highly restrictive monetary policy. We now expect Fed rate cuts to start in March 2024, one quarter later than our previous December 2023 expectation. Combined with the additional July hike that to our profile following the June FOMC meeting last week, this leaves the fed funds rate 75bp higher at the end of 2024 compared with our pre-FOMC forecast, at 3.50-3.75%. This is still significantly lower than the latest FOMC median forecast of 4.6%, and this is due to the bigger hit to GDP growth and the bigger rise in unemployment that we expect. We think the combination of modestly falling payrolls and m/m core inflation close to – but somewhat above – the Fed’s 2% target will be enough to trigger the start of an easing cycle by next March.