Softer growth, cooler inflation and rate cuts remain on the horizon

Economic growth in the United States appears to be in solid shape. Although real GDP growth came in well below consensus expectations and amounted to just 1.6% annualized in Q1-2024, the headline miss was mostly the result of larger-than-anticipated drags from trade and inventories. Real final sales to domestic private purchasers (i.e., real consumer and business fixed investment spending) rose at a 3.1% annualized rate during the quarter.

Real GDP growth is again setting up to remain strong in Q2, with our current estimate in the 2%-3% range. We continue to see a modest deceleration in the quarters that follow, with growth slipping to just slightly below 2% in the second half of 2024.

Consumer spending has been remarkably resilient lately, and we currently anticipate another strong performance in Q2 in terms of growth in personal consumption expenditures (PCE). However, many households have exhausted the savings accumulated during the pandemic and are now facing significantly higher debt costs and more subdued inflation-adjusted income growth. As such, we anticipate real PCE growth to downshift in the second half of the year and to average about 1.6% annualized in the final two quarters of 2024.

Some additional slowdown in business investment also seems likely as capex spending remains challenged by higher financing costs. Manufacturing projects have boosted structures spending, but a sharp downshift in new commercial development in the wake of increased cap rates and deteriorating CRE fundamentals appears set to drag down overall structures investment.

Although strong recently, the labor market appears poised for moderation. We expect payroll growth to average roughly 135,000 per month in the second half of the year, a downshift from the 245,500 averaged so far in 2024. Slower employment growth and improving labor supply should generate a slightly higher unemployment rate, which we now expect to peak at 4.1% in Q4-2024.

In light of the recent flare-up, we have adjusted our core CPI and PCE inflation rates up slightly in the near term. Although concerning, the recent bump in inflation does not appear to be the start of another rapid run-up in prices, and softer inflation readings seem likely over the next few months. We estimate that the core PCE deflator will settle down and run at a 2.4% rate in the second half of the year.

Consequently, our view that 25 bps rate cuts will arrive in both September and December and that 2025 will bring an additional 100 bps of cuts has not changed. We readily acknowledge that it would not take much for the start of the cutting cycle to be pushed back until November. What's more, the risks to that call are heavily skewed toward there being one cut in 2024 as opposed to three cuts.

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