With the consensus view that the Fed will reverse course and begin cutting rates at the September meeting, key questions remain about the size and pace of these cuts. As such, we look at the year in review to assess the balance of economic indicators, which we believe suggests that the Fed initially will adopt a cautious and measured approach to rate reductions. A broader examination of various indicators reveals that many continue to support the case for a soft landing—with some even improving the economic outlook. While the US economy is humming along and, in our view, remains arguably stable, we recognize that there are emerging warnings signs of potential slowing economic conditions. In assessing the totality of the data, we categorize these as improving, steady, and worsening economic metrics.
Meaningfully Better (and Preventing a More Aggressive Pace of Easing)
While some might see uncertainty concerning the future of the US economy, we see several improving areas that provide lift to the economic outlook. Notably, both the overall labor force participation rate and the prime-age labor force participation rate have improved compared to one year ago, and the current prime-age labor force participation rate is at its highest recorded level in over two decades. An influx of new and returning workers has alleviated some of the labor market tightness that emerged following the pandemic when the ratio of unemployed individuals to available jobs fell to 0.5.
This easing of labor market conditions has consequently contributed to a moderation in wage growth, which has decelerated well below its 2022 peak. This deceleration has had an easing effect on price pressures, evident in current core inflation figures. Both Core CPI and PCE have declined substantially from their respective peaks as well as compared to 12 months ago, thereby slowing the erosion of consumer purchasing power.
Largely Unchanged but Neutral (and Prolonging a Fed Pivot)
Despite expectations that the Fed was nearing a pivot last December, a handful of areas failed to make meaningful progress and consequently delayed rate cuts. For instance, headline inflation figures have not declined as sharply as Core CPI and PCE over the past year. Nonetheless, overall inflation is moving in a favorable direction and the downward trend currently seen in price pressures may have positively impacted how consumers feel about the future. According to the University of Michigan consumer survey, expectations have improved slightly compared to one year ago and have begun to recover from the post-pandemic low figures seen mid-2022. In contrast, consumer sentiment on current economic conditions has worsened slightly over the last year. While expectations and current assessments are typically aligned directionally, the two sentiment indices began trending in opposite directions earlier this year.
Paradoxically, despite the decline in consumer sentiment, consumer spending remains robust as evidenced by retail sales figures and the current personal savings rate, which has remained low following the pandemic. While a lower savings rate may create a vulnerable consumer balance sheet in the long term, it supports US economic growth in the short-term. Furthermore, retail sales continue to rise year-over-year, albeit at a moderating pace. While it is uncertain whether the decelerating growth rate is a durable trend, there has been a notable shift in consumer spending patterns with consumers increasingly focused on value-oriented purchases.
Worse and A Potential Risk
Continued consumer spending is crucial, as it accounts for approximately two-thirds of US economic growth. Consumer behavior and spending patterns are in turn significantly influenced by the performance of the labor market. While the labor market remains relatively strong, recent developments pose potential risks. The unemployment rate has risen meaningfully over the past year, and the monthly change in nonfarm payrolls has shown gradual declines. Despite these emerging trends, the unemployment rate remains historically low, and the three-month moving average of monthly nonfarm payroll changes is consistent with the average from the previous economic cycle—though revisions have pulled recent figures down. Nevertheless, both unemployment and nonfarm payrolls are key labor market indicators to monitor going forward as any meaningful degradation represents a risk to the outlook.
Coupled with concerns for deterioration in the labor market, the housing market continues to face challenges. While new home sales have seen a slight increase compared to last year, single-family starts, multifamily starts, and existing home sales have declined over the past 12 months, signaling potential issues from an economic perspective. However, we anticipate that the expected easing of monetary policy in the near future could help improve housing market conditions going forward, but we also anticipate that we will see supply constraints reemerge before the Fed has completed its easing cycle.