Category: Foreign

The Foreign Press Centre’s Wall Street series provides access to experts on U.S. and global economies. In this briefing, Mark Zandi, the chief economist at Moody’s Analytics, shares his 2024 U.S. economic outlook.  United States Bureau Chief OLUKOREDE YISHAU, who was at the briefing, reports that the U.S economy is experiencing boom and is expected to continue so barring unforseen circumstances. Excerpts:

The United States economy

I think the U.S. economy is performing well, and prospects, economic prospects, let’s say through this time next year, are good.  I’ll give you a few reasons for that optimism, and then I’ll buy it back a little bit, talk a little bit about the risks, and maybe if we’ve got a few minutes, I’ll give you a couple indicators to watch to gauge whether my optimism is coming to pass or whether the economy is going to struggle more than I’m anticipating.

And just to give you a couple – a few numbers just to give context, real GDP – that’s the value of all the things that we produce – that grew about 2.5 percent last year in calendar year 2023, which is – which is good.  A typical year would be close to 2 percent, so 2.5 percent is a good year.  And I expect growth in 2024, calendar year basis, to be about the same, about 2.5 percent.  That’ll be enough to keep unemployment low. 

Unemployment rate

The U.S. unemployment rate is 3.7 percent; I expect that unemployment will remain below 4 percent throughout the year.  It will create lots of jobs; right now average monthly job growth is about 250,000, which is very strong.  I expect that to throttle back just because it would be very difficult to maintain that kind of growth without overheating; so I expect by the end of the year, it will be growing closer to 100K per month, which is kind of consistent with underlying labor force growth.

Inflation rate

And I do expect inflation and interest rates to continue – inflation will continue to moderate and interest rates to come down, and I’ll come back to that in just a second. Okay.  So that’s staging the numbers.  It kind of gives you context that it’s all pretty good.  Let me give you a few reasons for the optimism.

Reason number one: inflation is coming in.  It’s moderating reasonably gracefully.  There are lots of reasons why the U.S. and other global economies have suffered high inflation, demand and supply, but at the top of the list of reasons is the pandemic and the Russian war in Ukraine.  The pandemic scrambled global supply chains, labor markets; the Russian war caused oil prices and agricultural prices to rise.  And those two shocks conflated and affected inflation expectations, which began to impact wage demands.  And that’s when inflation began to metastasize more broadly around the economy.  And that’s when the Federal Reserve became – started to raise interest rates very aggressively, back in early 2022.

But good news – Pandemic/Russian war effects are in the rearview mirror, and as those shocks have faded – there’s still residual effects, but as those shocks have largely faded, inflation has come in, and without a significant weakening in the economy.  The economy has continued to grow strongly, unemployment has remained very low, job growth strong; despite that, inflation has come in, and that’s because those supply shocks have – the effects of those supply shocks have faded.

Inflation is not quite back to the Federal Reserve’s inflation target.   The only big difference between actual current inflation and the Fed’s target is the growth in the cost of housing services.  But there, the good news is that’s tied – the growth in the cost of housing is tied to rents, market rents.  And we know that market rents over the past year have been very soft, flat to down.  And that’ll continue for the coming year, and that goes to the fact that we now are getting a lot of supply.

I mentioned the pandemic scrambling supply chains.  It did so in the multi-family construction industry, made it very difficult for developers, builders, to get appliances and building materials, and of course the labor market was disrupted and it was hard to get labor to construct a multi-family property.  But as the pandemic has faded and the supply chains have normalised, labor markets are back to something more typical. 

We’re getting those units completed, and that means that it’s causing vacancy rates in the apartment market, the multi-family market, to rise, put downward pressure on rent.  And that’s really good news for the growth and cost of housing services.  And that’ll become – it’s already becoming evident, but that’ll become much more evident in the coming year.  And I expect by the end of the year, inflation will be back to the Federal Reserve’s inflation target.  There won’t be any questions about that.

Second reason for optimism

With lower interest rates – excuse me – with lower inflation, interest rates should decline.  I do expect the Federal Reserve to start cutting interest rates.  There’s a debate as to exactly when.  At this point I expect the first rate cut to be at the May meeting of the Fed, a quarter point, and then roughly a quarter point reduction in rates each quarter going forward until the federal fund rate target – the key interest rate the Federal Reserve controls, which is now sitting a 5.5 percent – gets back to its so-called long run equilibrium rate, so called R-star, the rate consistent with monetary policy, neither supporting or restraining economic growth.  And that’s somewhere around 3 percent.  So they’re going to bring the fund rate target down from 5.5, where it is currently, to 3 over the next couple-three years.

I don’t expect any meaningful change in the long-term interest rates.  The 10-year Treasury yield is around 4 percent.  That’s where I think it should be in the long run.  So with falling short-term interest rates, the federal fund rate target and stable long-term rates, the so-called yield curve, the difference between short and long rates, will become more normally sloped, to be positively sloped with long-term rates higher than short rates, which is really important for the financial system and the banking system, which I’ll come back to in just a minute. 

Another reason for optimism

The American consumer is driving the train, not only here in the United States but globally.  I mean, American consumers are buying everything that’s produced here and then lots of what’s produced overseas thus the trade deficit.  And so unlike in the early parts of the pandemic or in the financial crisis back 10-15 years ago, when the Chinese economy led the global economy, it’s the U.S. economy, and particularly the American consumer, that’s leading the way here in terms of economic growth.

And all the fundamentals look good.  Inflation – because inflation’s back down.  Wage growth is now stronger than inflation, so people’s real wages are increasing.  Their purchasing power is improving.  That’s the fodder for more spending.  I mentioned low unemployment and jobs, all very positive.  Debt service – that’s the percent of income that consumers must devote to servicing their debt – remains very low.  It’s not increasing in any meaningful way.  And that goes to the fact that American consumers, unlike consumers in most other parts of the world, have been able to lock in the previously record low interest rates.  They’ve got long-term, 30-year fixed-rate mortgage debt, and that’s not adjusting, unlike what’s happening in Canada and many parts of Europe and parts of Asia.  So that’s insulated the American consumer from the higher rates that the Fed has implemented. 

Asset prices are up.  People are a lot wealthier than they were when the pandemic hit.  Stock prices are at record highs.  Housing values – they kind of stumbled in early 2022 when the Fed first started to raise rates, but they’ve stabilized now, are starting to rise again.  In fact, nationwide house prices are up 50 percent from where they were four years ago.  And there’s still plenty of excess cash built up during the pandemic, particularly among high-income households, to a lesser degree middle-income households.  Lower-income households have struggled more.  They’ve blown through their excess saving and have turned to credit cards and consumer finance loans to help support their spending, but the bulk of the spending is done in the top part of the income distribution and in the middle parts of the distribution, and there the household is sitting in good shape with a lot of excess saving.  So everything looks good with regard to the consumer, and as long as the American consumer does their thing, the economy should be fine.

The risks

I will say the risks to the outlook are more symmetric than they have been in a long time, meaning yes, there are downside threats to the optimism I just expressed, but things could actually turn out better than I’m anticipating, like 2023.  That turned out to be even better than anticipated, which goes to some real improvement on the supply side of the economy – stronger productivity growth and strong labor force growth.  But I won’t focus on that.  I’ll just mention a few risks to the downside, and this is chronological, what could do us in most immediately.  And just to be symmetric, I’ll give you three downside risks.  I gave you three reasons for optimism; I’ll give you three downside risks.

First, oil prices.  I forecast many things.  Some things I’m confident in, some not so much.  Oil prices are very difficult to gauge.  We’ve been fortunate, certainly for the U.S., that oil prices have – and much of the developed world – that oil prices have remained low despite cuts in Russian production due to the sanctions and, more significantly, cuts by Saudi Arabia to try to stabilise the price.  But we’ve seen a lot of oil production.  The pickup in oil production in the U.S. has been very dramatic, and that’s more than offset the reduction in supplies coming from Russia and Saudi.  And moreover, the Chinese economy has been soft, and that’s curtailed or crimped demand for oil, and so we’ve seen oil prices kind of hanging between $70-80 a barrel.  Right they’re closer to 80 than 70, but that’s kind of where they’ve been.

Reasons for concern

And in my baseline optimism, my expectation that oil prices will be in the coming year in the – more in the 80s than the 70s, but there is a risk that prices could jump higher.  There’s a lot of geopolitical flashpoints that could disrupt oil supplies around the world, the obvious in the Middle East – the Houthis in the Red Sea, potential for Iran’s – Iranian production to be disrupted given what’s going on there.  These aren’t – I don’t expect these things to happen, this is not my baseline, but obviously there’s a lot of risk around that.

And I don’t think we can count on the U.S. oil producers, the frackers, to continue to ramp up production.  Much of the increase in production was based on wells they had already drilled but had not used, and they just took them – they were dormant and they opened them and started to pump oil.  But that’s over.  There’s no more room there, and so it’s difficult to see U.S. production picking up to any significant degree.  Other countries can produce more oil, but not enough if we see some disruption, and so I would watch that carefully. 

Nothing does more damage to the U.S. economy and really the – most of the global economy than higher oil prices.  It undermines people’s purchasing power, it undermines consumer sentiment.  Cost of a gallon of regular unleaded is kind of central to people’s thinking when they think about the economy, and it also affects inflation expectations of bond investors and consumers, which goes back to the Fed.  If inflation expectations increase because of higher oil prices, makes it less likely the Fed will cut interest rates or may even at some point have to raise rates, and that will be a problem.

Second reason for some nervousness is what’s going on in the U.S. banking system.  The banking system is stable but it’s fragile.  The fragility goes back to the crisis of a year ago when the Federal Reserve stepped up, provided liquidity, a liquidity facility to the banking system, and the other regulators and the Treasury decided to ensure depositors whether they’re below or above the FDIC insurance limit.  So things have settled, but the – kind of the fundamentals of the banking system remain very, very vexed.  I mentioned the yield curve earlier.  As long as the curve is inverted, short rates above long, it makes it difficult for the banking system to maintain its profitability, because it tends to fund itself short at short-term interest rates, lend long at long-term interest rates, and if long-term rates are below short rates, they can’t make money or certainly much more difficult to do that.

Loan growth has weakened because of the tightening in underwriting in the wake of last year’s banking crisis, and we are starting to see some erosion in credit quality, particularly in the commercial real estate market.  Small or mid-size banks in particular have pretty high – significantly high exposures to CRE, commercial real estate.  Across the banking system, almost 25 percent of bank assets are in CRE: mortgages, commercial mortgage-backed securities, loans to real estate companies.  Not the large banks – I’m not worried about them.  Their exposure is low and they’ve capitalize to pretty dark stress test scenarios where prices are simulated to come down peak to trough about 40 percent, which is something that’s not going to happen. 

But for the smaller banks, mid-size banks with high exposure and lesser capital, we likely will see some bank failure.  And in the baseline, in my baseline worldview, optimistic worldview, that shouldn’t be a problem.  They’re not systemically important institutions.  It shouldn’t be an issue.  But depositors are on edge.  They’re cautious, they’re nervous, and you can construct scenarios where if you see a rash of bank failures, we see another deposit run, and that would put tremendous pressure on the banking system and by extension the economy, so second risk to watch.

And the third – and I won’t dwell on this unless you want to talk about it, but the third is the political environment.  We’re in the middle of an election process.  This is something that’s happening in different parts of the world, but particularly here in the U.S., and it’s very likely the election for president is going to be very close and potentially contested.  That could create a lot of volatility in financial markets and undermine consumer sentiment, and that’s an issue to watch. 

And more fundamentally, on the other side of the election, this time next year, lawmakers will be faced with a number of significant issues.  They’ll have to raise the Treasury debt limit again.  The Trump tax cuts for high-income, high-net worth households expire.  Some Obamacare tax subsidies will wane.  So a lot of decisions to be made, and that’s really key – how lawmakers address those decisions is really key to addressing the nation’s long-term fiscal challenges.  As you know, the nation’s debt to GDP ratio has risen quite dramatically over the last 25 years, and all the forecasts done by the CBO, Congressional Budget Office, the nonpartisan group that does the budgeting, shows that the – if there’s no change in policy, debt loads will rise very dramatically, and that will ultimately become a problem for the economy.

Assessment of Artificial intelligence on the global productivity of the U.S.

On AI, no, I don’t think AI has played a role in impacting measured productivity growth in the U.S., at least not so far.  As you may be aware, productivity growth over the last year has picked up quite a bit.  Hard to know whether that’s cyclical, temporary, or whether that’s part of something longer term.  But I don’t think any of its related to AI.  If there is a – if you can – if we can pinpoint a reason for the improvement of productivity, it may be that goes to all the quitting that workers did back 1, 2, 3 years ago.  Many of those workers got into jobs that are much more suited to their skills, talents, and interests.  And as they’ve moved up the learning curve, they’re now at a place where they’re more productive.  So that would indicate that – that would be more of a one-time boost to productivity growth as opposed to kind of a shift in underlying trend in productivity gains. 

So I don’t think AI has played a role yet.  In fact, it may be the case in the near term that it’s counterproductive for productivity growth as businesses kind of shift their business models and their business practices and make investments in talent and equipment and other things necessary to engage in AI more effectively.  That could weaken productivity growth in the near term.  So I don’t think we’ve seen any improvement in productivity due to the – to AI. 

I do think it’s reasonable to expect AI to be a – to add to productivity growth going forward.  I mentioned earlier – I forecast many things.  Some things I’m confident in, like the inflation going back to the Fed’s target, some not so much.  My outlook, my expectation for AI and productivity growth is not so much.  Very difficult to gauge.  My sense is that the – it is an important technology.  It’s probably not as game-changing technology as, say, electrification back in the 1920s here in the U.S. or even the internet back in the 90s and 2000s. 

More – it’s more like – the analog might be more like the adoption of wireless technology.  So it’s a plus; it’s going to add to productivity growth.  But I don’t think it’s going to be this game-changing technology that’s going to result in huge productivity gains, which on the flip side of that would mean large job losses and probably higher unemployment for an extended period of time. 

In our – now, I do explicit forecasts that clients use.  Many foreign banks are clients of ours.  So I have to put pen to paper and I have to make an explicit assumption about things like what will AI do due to productivity growth.  So if you look at our forecast, the assumption is that AI will lift underlying trend productivity growth in the United States by about 15 basis points over the next decade.  That’s 0.15 percentage points per annum over the next decades.  So instead of growing, let’s say, 2 percent per annum, which would be before AI, it’s closer to 2.15 percent, which you look at – some people will look at that and say, oh, that’s not that meaningful.  But if you add up that 15 basis points per annum over a 10-year period, that’s real money.  That’s significant economic growth.  But it’s not – it’s not percent per annum or 2 percent per annum.  It’s not that. 

But again, I preface all of that by saying I have this great deal of uncertainty here.  One other point about that before I move on.  The real gains in productivity from technological change occurs over time as new businesses form and optimize around the new technology.  When existing businesses take a new technology and try to change their business model, and their organisational structure, and their – the type of people that they have working, and the equipment that they have, that – that only takes you so far.  It’s very difficult to reorient big companies to a new technology and really take advantage of that new technology. 

But when new companies form, they optimize around the new technology.  So new companies are – like, they’re optimizing around remote work.  They’re not optimizing around the use of an office space.  And they’re going to optimize around AI and – and so over time, we will see the productivity gains, but it will be over time as new businesses form.  It’s not – I don’t think it’s going to be a game-changing event.  But again, I state all of that with a great deal of uncertainty. 

The impact of the China slowdown on the global economy

I’m of a mixed mind, I mean, at least so far.  I mean, the slowdown in Chinese growth does – China is a large economy, very important to global trade, and if the Chinese economy is soft, then that means less demand for things that are produced all over the world, including here in the United States.  So that has – by itself would be a weight on economic growth.  But at this point in the business cycle when we’re really focused on inflation and the Federal Reserve has been raising interest rates in an effort to slow growth, that may not be so bad. 

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I mentioned that in the context of oil prices.  I mean, oil prices are soft.  We’ve been in the 70s for a barrel of oil – of Brent, WTI – as opposed to the 80s, and that may be in large part because the Chinese economy has been kind of flat and has not – the demand for oil hasn’t picked up to the degree that it would otherwise and therefore that’s kept oil prices down.  And oil is symptomatic of other commodity prices, so generally commodity prices have remained down.  And in fact, Chinese inflation has been very weak.  We’re seeing not only disinflation but outright deflation, and that’s translating through in the form of weaker import prices here in the U.S. and globally, which has kept inflation down.  So in the current context when the issue is inflation and growth, the problem – the weak Chinese economy has not really been a significant issue or problem.  And so I view it kind of – hard to – it’s hard to say good or bad.  It’s been just more mixed. 

I do think another downside – I gave you three downside risks.  A fourth downside risk, if I – if I had more time would be the problems in the Chinese economy.  It is struggling on a more structural basis.  It’s got all kinds of issues with regard to demographics.  It’s got issues with regard to issues around debt levels and leverage.  Its property markets are over – vastly overbuilt.  There’s increasing bankruptcy, default on mortgages, and other financial linkages to the real estate sector.  There’s the vexed relationship with the United States which is affecting both countries, but affecting China more because it’s a much more open economy than the U.S.  So I do think the Chinese economy is – and, of course, the – kind of the shift in kind of governance in China over the past decade is also probably playing a role in its difficult kind of economic performance. 

So broadly speaking I think the Chinese economy is going to continue struggle.  And I don’t – long run I don’t think that’s good for the Chinese people or the global economy.  That’s not a good thing.  But for the immediate here and now, kind of a softish Chinese economy has kind of helped out here keep inflation under – keep inflation down and allowing central banks, like the Federal Reserve, to avoid having to raise rates even more than they have up to this point in time.