The Economy Greatly Outperforms Expectations, Markets Prepare For A Pivot

Financial markets begin 2024 once again preparing for a pivot of the U.S. economy and monetary policy.

One year ago, negative GDP growth was expected for the first half of 2023 (a recession), according to Bloomberg. Instead, data from the first three quarters showed the economy was on pace to expand by 3% in 2023 (fourth quarter data is not yet available). That’s well above the widely accepted trend rate of 1.8%. The current Bloomberg composite forecast once again portrays a more pessimistic view of the economy in the first half of this year before picking up steam in the second half.

One could argue that any economic sluggishness would more likely occur later in 2024 than earlier given the momentum from 2023. Regardless, below is a list of economic and market themes ALM First is contemplating as the new year begins.

1. Consumer spending finally cools.

A major theme of the past two years has been a torrid pace of consumption by U.S. households, greatly exceeding broad economist expectations. As ALM First has noted several times during that time, this consumption was greatly fueled by COVID-era stimulus and pent-up demand, which pushed aggregate household liquid assets significantly higher relative to longer-term trends. However, as noted in last month’s commentary, inflation and heavy spending appear to have finally eroded this excess liquidity for all but the top two income brackets, which should lead to a slower pace of spending in 2024.

2. Inflation cools but could be stickier than expected.

Inflation rates surprised to the downside in the second half of 2023, fueling market optimism of a sooner and more aggressive Fed pivot this year. However, much of this has been attributable to what are typically more volatile components of core inflation, which could be poised to rebound in the first half of 2024.

Additionally, there are other long-term factors that could drive stickier inflation in the years to come. Namely, the growing trend of anti-globalism politics and heightened geopolitical turmoil across the world. A reduction in global trade and economic cooperation can be inflationary and could be a headwind for global central bankers attempting to keep inflation subdued.

3. Monetary policy and rate volatility.

Financial markets have recently priced a very dovish path for Fed interest rate policy in 2024 and beyond, and there have also been recent rumblings that the Fed’s quantitative tightening (QT) program might have to slow/end sooner than policymakers would prefer.

As 2023 ended, fed funds futures were priced for 150 basis points of rate cuts in 2024, double the median Fed forecast from the December 14 FOMC meeting. If inflation does indeed prove stickier than markets expect, the Fed might have to keep the funds rate on hold well into 2024. This scenario would likely keep rate volatility elevated as markets continue to swing back and forth as fresh data is released, and elevated rate volatility has coincided with poor market liquidity in recent years.

Visit ALM First to read about the latest economic data and overall market trends in the January 2024 Market Commentary.