US economic outlook: a cooler climate as the US economy enters Q4

With economic strength persisting in Q3, the US is likely to avoid a recession this year. We revise up GDP growth in 2023 and 2024 by 0.6ppts and 0.4ppts respectively, but do not foresee a sustained reacceleration and expect a significant growth slowdown in 2024. After an estimated 2.1% real GDP growth in 2023, we expect 0.9% growth in 2024. Headline CPI inflation is seen averaging 4.0% in 2023 and 2.5% in 2024, with the Fed cutting interest rates by an expected 100 basis points to 4.375% by year-end 2024. We see the 10-year Treasury yield at 3.9% by year-end 2023 and 3.5% at year-end 2024.  

• A recession in 2023 is unlikely, we believe, prompting a 0.6ppt increase in our 2023 real GDP forecast. We revise up our 2024 growth forecast by 0.4ppts to 0.9%, but this remains well below trend.
• Core inflation continues to make progress, and we expect a slowing economy will lower CPI inflation to 2.5% in 2024 versus 2.8% in our prior baseline.
• We see the hiking cycle as complete, but expect the Fed to be cautious about starting to ease. We now forecast 100bps of interest rate cuts in 2024, versus 150bps previously.
• We lift our year-end forecast for 10-year Treasury yields to 3.9% for 2023 and 3.5% for 2024. 

"Easy" disinflation is over. The deceleration in core CPI is continuing, with core inflation rising by 0.3 percentage points (ppt) but slowing in annual terms to 4.3% from 4.7% in July. Used car prices fell 1.2% on the month, helping to moderate core goods inflation by 0.1%. The core services basket also moderated to an annual pace of 5.9%, its slowest pace since July 2022. Shelter inflation decelerated for a fifth consecutive month to 7.2% y-o-y. The progress on both core goods and services disinflation (see Figure 1) supports our view that headline inflation will average about 4.0% this year and cool to a 2.5% average in 2024, down from 2.8% previously. However, headline CPI inflation snapped higher to 3.7% year-on-year in August, from 3.2% in July, as energy prices rose 5.6%. More than half of the rise in the headline index stemmed from higher gasoline prices tied to oil supply cuts by OPEC. If this goes on, we could see upward pressure on both headline and core inflation metrics. 

Figure 1. US core inflation measures   

We see the hiking cycle as complete, but the easing cycle still distant. The encouraging signs of moderation in recent inflation and labour market data, suggest the Fed has reached its terminal policy rate, but given the remaining economic strength, rate cuts are not imminent. Real GDP growth has been above its 1.9% potential trend since mid-2022 and consensus growth estimates for Q3 2023 suggest this will continue, especially given buoyant consumer spending despite ongoing erosion of savings and still-elevated inflation. As a result, we now see just 100bps of interest rate cuts by the FOMC next year (see Table 1). However, we continue to anticipate a significant growth slowdown to take hold in 2024, particularly as downside risks to economic activity have escalated in recent weeks. These include a significant autoworkers strike, a likely government shutdown¹, and the restart of student loan payments from October. Although we don't expect these temporary factors to drag growth into recession territory, they may have deeper implications if they persist into 2024. We expect weaker growth and cooling inflation to lower the 10-year US Treasury yield to 3.9% by year-end 2023 and 3.5% by year-end 2024.  

Table 1. Swiss Re Institute key forecasts 

So far, the job market is softening in an orderly manner. The August 2023 jobs report showed another solid increase in payrolls, but sharp revisions in the prior two months reiterated that the labor market is loosening albeit from historically tight levels. While the economy added 187 000 jobs, the three-month moving average fell to 150 000 – the slowest pace since January 2021. While the unemployment rate rose 30bps points in August to 3.8%, this entirely reflected an encouraging 736 000 increase in labour supply. A larger pool of available labour puts downward pressure on wage growth, which ticked lower to 4.2% year-on-year in August – consistent with broader wage measures that show easing price pressures including the Employment Cost Index, the Indeed wage tracker, and the Atlanta Fed's wage growth tracker (see Figure 2). The latest vacancies data highlights recent labour market cooling, with job openings declining 338 000 to 8.8 million – the lowest since March 2021 – as the vacancies to unemployed ratio also eased to 1.5 from a peak of 2.0. The quits rate – a proxy for worker confidence - fell to roughly its pre-pandemic rate of 2.4%. Initial jobless claims remain historically low at roughly 230 000, unadjusted continuing claims have shown a gradual uptrend in 2023. 

Figure 2. US wage growth indicators   

We continue to expect a recessionary environment. While our near-term growth outlook has turned more positive, our baseline continues to expect five consecutive quarters of below-potential GDP growth. Though the tightening in bank lending has not choked-off the expansion, business loan demand has remained weak in the months following March's bank failures. Consumer spending has weathered the surge in interest rates so far, as demonstrated by a sharp 0.6% increase in real consumer spending in July. However, we expect the fiscally supported strength of household balance sheets to deteriorate over the coming months as wage growth slows and rising interest costs drive debt payments higher. Savings rates have reversed the uptrend developed from late 2022 into Q2 2023, falling to 3.5% in July and suggesting consumers continue to spend out of savings. Meanwhile, the latest business surveys reflect an improvement in sentiment. The ISM manufacturing index rebounded in August by 1.2 points to 47.6 but remains in contraction territory. The ISM services index rose 1.8 points to 54.5 – its strongest level since February.