S&P Global Ratings now expects U.S. real GDP growth of 1.6% between the fourth quarter of 2024 and the fourth quarter of 2023 (up from our 0.8% forecast published last November), and U.S. real GDP growth of 2.4% in full-year 2024 (up from our previous 1.5% forecast).

The real GDP growth we forecast for full-year 2024 is slightly weaker than the 2.5% growth the U.S. saw in full-year 2023 (according to the U.S. Bureau of Economic Analysis' preliminary estimate), but it's in line with the 2.4% average during the 2010-2019 economic expansion. Better-than-anticipated real GDP growth in the fourth quarter of 2023 and a jobs market that appears sturdier than implied just one month ago led us to revise up our forecasts.

In fact, U.S. economic expansion exceeded our expectations throughout the second half of 2023. The Bureau of Economic Analysis' preliminary estimate for growth in the fourth quarter of 2023 from the same quarter a year before was 3.1% (versus 0.7% in 2022). A weak first half (with a seasonally adjusted rate of growth of just 1.1%) was followed by a strong second half (with a seasonally adjusted rate of growth of 4.0%). The strength in net exports, government spending, and the pace of inventory accumulation surprised us. Better-than-expected fourth-quarter GDP growth provided a 0.4-percentage-point statistical carry-over effect to our 2024 annual average forecast published last November.

Beyond favorable year-end base effects, economic activity in the first quarter of 2024 has been running warmer than we anticipated. Consumer spending is benefiting from a strong labor market. The economy added 353,000 net new jobs in January, and the December jobs data was also revised up significantly, both reversing the downward trend of earlier months. Average hourly earnings growth (0.6%) was twice what we expected in January, and data revisions by the U.S. Bureau of Labor Statistics have showed that most people's wages outside of the retail, leisure, and hospitality industries have been rising faster than previously estimated. The labor market continues to create jobs while wage gains remain above the rate of inflation, leading to sustained purchasing power for consumers.

Survey trends suggest manufacturing may have found a floor for now and will start adding to growth (albeit modestly) during the year. But restrictive monetary policy will continue to weigh on interest-rate-sensitive business and residential investment. The public sector will likely continue to add to growth, but at a tempered pace compared with last year. State and local government expenditures in 2024 may be more constrained by balanced budget rules since the strength of state and local government finances last year may have faded as revenue slowed. And trade and stock-building are poised to become net neutral to GDP growth.

Weakness has been rolling from sector to sector, and it's likely to move from goods-producing sectors to services sectors over the course of the year. We still think the economy will go through a period of cyclical adjustment to below-trend growth as the year progresses, even as it avoids a recession. But forecasting the timing of a cyclical slowdown has been trickier this time around given the unique features of the current business cycle.

Table 1

The Labor Market Remains Sturdy, But Not Without Hints Of Moderate Softening

We have lifted our estimates for 2024 job growth in response to higher economic growth, and we now look for payrolls to expand at more than a 100,000 monthly rate through the second quarter. Weaker sequential GDP growth starting in the second quarter will cause demand for labor to slacken further in the second half (due to usual lags from GDP to employment), and the unemployment rate will drift higher in the next two years, to 4.3% in 2025 (the longer-run steady-state consensus estimate is 4.1%-4.4%).

The unemployment rate held steady at 3.7% in December and January, and it has now been below 4% for two years. At the same time, labor supply and demand are coming into better balance: Last year, rebounds in the labor participation rate and immigration levels back to pre-pandemic norms eased the severe labor market imbalance that we saw in 2022.

We think the labor participation rate will continue to edge up this year while the high-pressure economy brings more people off the sidelines and into the labor force. But beyond this year, we anticipate the labor participation rate moving lower as the ongoing retirement trend among baby boomers dominates.

As sturdy as the labor market may look, there are signs that it has been softening:

• Measures of labor market churn have normalized: Layoffs, the quit rate, the hiring rate, the labor participation rate, and the ratio of detrended job openings to unemployed workers are now near or at 2018-2019 levels.
• It has started to take longer for laid-off workers and employed workers to find new jobs, even as the overall level of layoffs remains relatively muted.
• Jobs growth is increasingly dependent on acyclical sectors such as the public sector and health care.
• The percentage of small businesses that are planning to hire is back down to its 2017 level, according to a survey by the National Federation of Independent Business.
• And employment in the temporary help services sector, a tried-and-tested leading indicator of the labor market, was down 7% in January from a year before. In the past, large declines have been harbingers of weaker demand to come for permanent workers.

Labor Productivity Keeps Unit Labor Costs In Check, For Now

Even amid these other labor market trends, wage growth remains elevated compared with the pre-pandemic normal even though it has slowed. Private wages and salaries from the Employment Cost Index, which isn't affected by compositional issues and has less statistical noise, slowed to a 4.3% year-over-year increase in the fourth quarter of 2023. But labor productivity growth has also risen, keeping businesses' unit labor costs in check.

Indeed, nonfarm business labor productivity rose at a staggering 4% annualized rate in the second half of 2023. By contrast, between the fourth quarter of 2021 and the fourth quarter of 2022, implied labor productivity fell by 2%. Productivity gains in 2023 were almost enough to bring productivity back to the pre-pandemic trend.

We think it's too early to chalk up this current strength to the early stages of a revolution in artificial intelligence. It's more likely that the cause is a cyclical response to rising capacity utilization of available labor: Stronger labor demand relative to supply has forced businesses to find other ways to increase output, such as investing in automation and increasing the efficiency of existing workers.

Over longer stretches of time, productivity growth tends to be relatively stable. We expect productivity growth going forward to stabilize near its 30-year trend range of 1.0%-1.5%. Leading indicators of wage growth (such as the quit rate) and real-time alternative indicators (such as the wage tracker from the job postings website Indeed) lead us to expect a continuing moderation of wage growth--to 3.5%-4% in 2024, which is consistent with trend labor productivity growth (1.5%) and the inflation target (2%).

Disinflation Has Been Uneven

Against the backdrop of a full-employment economy, aggregate inflation--as measured through the main personal consumption expenditures (PCE) price index, the Federal Reserve's preferred gauge--has improved remarkably, to 2.6% year on year from 7.1% at its peak in June 2022. Annual core PCE inflation stands at 2.9%, with the monthly annualized price change running at a 2% average over the last six months, when economic growth accelerated.

A significant contributor to the normalization of price pressures thus far has been goods and commodities sensitive to supply conditions, as global production, warehousing, and distribution have largely returned to normal. But it hasn't just been a supply-side story. Half of the decline in core PCE inflation from its peak was due to a decline in the contribution from demand, according to research by the Federal Reserve Bank of San Francisco.

Viewed within the framework of relative price adjustment between goods and services, the spike in inflation that surging goods prices ignited has now been tamped down by improved supply conditions and tighter monetary policy. The surge in goods prices, however, squeezed the margins of service providers and, as a consequence, put relative prices out of kilter. While a significant amount of disinflation has come through the goods sectors, we have seen less--though still meaningful--progress on services inflation. The persisting divergence between core goods inflation and core services inflation in the Consumer Price Index report for January is a reminder that we remain in the middle of an adjustment in services prices--an adjustment that can be bumpy.

Despite uneven progress so far, we think there will be more disinflation in services in the first half of 2024. Still falling goods prices will enable more of an adjustment to relative prices without services prices needing to rise. And stable inflation expectations will prevent new upward momentum in goods and services prices from developing. Core services--excluding housing, which is more closely associated with the labor market--should see continued disinflation given the continued moderation of wage growth, the normalization of companies' price-setting behavior, and anchored expectations.

There are also noneconomic reasons to consider. Inflation in medical prices (including drug pricing) in the PCE index will remain cool because of effective government price controls. And the price of shelter, another large part of the index, should moderate in coming months given the lagged effects of rents leveling off though 2023.

Progress toward lower inflation will likely be slow since the initial benefits of normalizing supply conditions are behind us and since consumer demand isn't wilting away as fast as previously expected. The lack of a new negative output gap cautions against expecting much more downside in cyclically sensitive goods prices. Continued gains in real income support consumer spending, but stronger demand also risks interrupting the decline in inflation.

At the same time, supply-side forces (such as increasing labor productivity) could reverse, and disruptions from conflicts around the world (between Israel and Hamas and between Russia and Ukraine) could reignite inflation.

We continue to forecast that core inflation (that is, inflation excluding volatile energy and food prices) will finally fall closer to levels consistent with the Fed's 2.0% target on a sustained basis by the middle of this year. Absent a shock, current economic forecasts suggest that the balance of risk on PCE inflation is tilted toward it averaging 2%-2.5% in the second half of 2024--a bit higher than the target and higher than the 1.6% average in 2010-2019.

How Will The Federal Reserve Respond?

Inflation data will continue to get most of the Fed's attention this year as it tries to fine-tune the timing of rate cuts. Sustained disinflation has opened the door to the first steps in monetary policy easing. But while they now formally expect the next move in rates to be down, the timing of the first move is still an open question. The Fed is in a data-dependent, "wait and see" mode.

Our forecast is that month-over-month core PCE inflation will run at a 2%-2.5% annualized rate, on average, for the first half of 2024 (with a hotter reading being likely for January given the Consumer Price Index and Producer Price Index reports for that month). That would bring 12-month core PCE inflation below 2.5% during the second quarter, with further declines anticipated this summer given high-base effects from the summer of 2023.

During a news conference last December, Fed Chair Jerome Powell suggested that the central bank must reduce the policy restriction on the U.S. economy before inflation reaches 2%. If the Fed holds back from cutting rates until the 2% inflation target is reached, the fear is that the U.S. economy could suffer because of the lagged effect of monetary policy. Cutting rates sooner rather than later would also be in line with the Fed's intention to not undershoot the inflation target.

We continue to think the Fed's first rate cut will be in June and that it will lower the benchmark rate by a total of 75 basis points (bps) over the course of full-year 2024--with one 25-bp cut each in the second, third, and fourth quarters). We still project a weaker economy in the second half of 2024 than in the first half.

The futures market has pared back somewhat the expectations it had earlier this year for rate cuts. It now anticipates a first cut in June and cuts totaling 100 bps over the course of 2024 (at the start of the year, it had expected a first cut in March and cuts totaling 150 bps).

The risk is that, if some of the disinflation of the past year does turn out to be temporary, it would reduce the appeal of lowering interest rates as much as is currently priced in. Strong wage gains and robust consumer spending are why Powell, in his recent comments, pushed for patience on the timing of rate cuts.

The conversation within the Fed about the pace of its quantitative tightening suggests an increasing chance that it might be scaled back within the next few months (much sooner than the scaling back in 2025 that we had previously presumed). Such an announcement may work to loosen financial conditions even more than what the Fed would otherwise like from just rate cuts. All else being equal, looser financial conditions leave the Fed more worried about achieving its price stability mandate. If the Fed doesn't maintain sufficiently tight financial conditions, there's a risk that inflation will pick back up and reverse the progress that has been made so far. It would suggest that the earlier slowdown in quantitative tightening would likely be more consistent with the Fed taking a more gradual approach to rate cuts than what is currently being priced in.

Table 2

Related Research

• Liquidity Outlook 2024: Five Questions, Five Answers, Jan. 30, 2024
• Economic Research: U.S. Business Cycle Barometer: Recession Risk Moderates, But Growth Is Limited By Potential, Jan. 26, 2024
• Economic Research: The Fed Pivots, Holding Rates Steady With Surprisingly Dovish Tilt, Dec. 14, 2023
• Economic Research: Economic Outlook U.S. Q1 2024: Cooling Off But Not Breaking, Nov. 27, 2023