This Week’s Developments in the US Economy

The Silver Linings of Higher for Longer

Approaching the second half of 2024, the resilient US economy has exceeded expectations while inflation has stalled—at least temporarily. As a result, expectations for rate cuts have shifted meaningfully from the beginning of the year, in turn impacting both capital markets and real asset activity. In several key areas – particularly inflation, monetary policy, labor market conditions, and consumer spending – many expectations for mid-2024 diverge from the place in which we find ourselves right now.

While inflation has improved compared to the 2022 peaks of 7.1% for headline PCE and 5.5% for core PCE, inflation has not declined as quickly as the Federal Reserve and market observers anticipated. The Fed revised their projected year-end 2024 Core PCE figure from 2.4% in December's Summary of Economic Projections (SEP) to 2.6% in March's SEP. Where this stall is concerning is the behavior of PCE core services excluding energy and housing, often referred to as "supercore" inflation, which has increased from 3.3% at year-end 2023 to 3.4% in the most recent reading.

Accordingly, market expectations have shifted, decreased the expected number of rate cuts in 2024 from six at year-end 2023 to between one and two. The main drivers of market expectations vary, including housing inflation, the labor market, and consumer spending. This week, we examine the current conditions of these factors compared to previous expectations to better understand their impact on future economic trends and policy decisions.

Housing Inflation and its Role during “The Last Mile”

One reason inflation figures have exceeded the Fed’s expectations is housing. The housing component within PCE experiences a lagged effect on inflation figures compared to current year-over-year rent changes. In April, rent of tenant-occupied housing and imputed rent of owner-occupied housing registered inflation readings of 5.4% and 5.7%, respectively, well above both Zillow’s and Apartment List’s rent indices, which showed 2.9% and -0.8% year-over-year rent changes. While official inflation measures for shelter components have declined from peak, they are not decreasing as quickly as real-time data suggests. This tracks with historic trends in lag time, but due to the outsized influence of shelter components, we believe strictly relying on current BLS calculations misleading with respect to accurately gauging inflation’s path towards the Fed’s stated target.

Moderation—but not Contraction--in in the Labor Market

Over the past two years, labor market gains have moderated, recently with a reading of 175K that aligned with the average monthly gains of 166K from the previous cycle. Despite this moderation, the labor market has outperformed expectations from a year ago, when broad-based declines and a rise in unemployment were anticipated by both the Fed and economists. In December, the Fed anticipated the unemployment rate to increase to 4.1% by year-end 2024. In the Fed’s March SEP, this estimate was revised downward to 4%. While a rise in unemployment has inched up 20 basis points from year-end 2023 to the current rate of 3.9%, it is important to note that unemployment levels remain below what has historically been considered maximum employment, and there have been few if any indicators of broad based structural weakness in the labor market.

What may give Fed officials some comfort given tight labor market conditions is slowing growth in real disposable income. In April, real disposable personal income, which accounts for inflation, decelerated to 1% year-over-year growth, well below the post-GFC average of 2.3%. In our view, this should contribute to further moderation of consumer spending, which would have disinflationary effects.

A Potential Slowdown in Consumer Spending

Despite various headwinds, consumer spending has remained resilient over the past year, continuing to support US economic growth and defying many previous expectations. Current year-over-year consumer spending figures, both real (2.6%) and nominal (5.3%), are above the previous economic cycle averages of 2.2% and 3.6%, respectively. However, the pace of consumer activity may be slowing. With slower growth in real disposable income and reduced personal savings many consumers are increasingly relying on revolving credit. This trend may lead households to be more restrictive in their spending and trade down in value after years of elevated spending and demand.

A modest slowdown may be underway, as indicated by nominal consumer spending dropping to 0.2% month-over-month in April following a 0.7% increase in March, and real consumer spending turning negative at -0.1%. Additionally, consumers spent less on recreational activities and dining out compared to the previous month, suggesting budget constraints. We believe this moderation may continue as consumers adjust to tighter financial conditions and prioritize essential expenditures amidst economic uncertainty.

A Hopeful Outlook on Monetary Policy

We believe we are beginning to see a confluence of figures supportive of an eventual loosening of monetary policy. Despite the fastest tightening cycle in decades, moderating but positive conditions in both the labor market and consumer spending have resulted in sustained growth in the US. GDP rose by 2.5% in 2023 and 1.3% in Q1 2024, defying early 2023 recession expectations. However, this growth has contributed to the Fed’s higher-for-longer stance, which presented challenges for capital markets and real asset activity. The key questions for the second half of the year are the extent to which distress may start playing a role and what conditions and rate policy shifts are necessary for markets to recover the pacing seen prior to the current rate tightening cycle.