- Americans are hopeful the Federal Reserve can achieve a so-called soft landing for the U.S. economy in 2024.
- The Fed projects U.S. GDP growth of 1.5% next year.
- Inflation is trending steadily lower but will likely remain above 2% in 2024.
The Federal Reserve has made significant progress in bringing down inflation while maintaining growth in the U.S. economy in 2023. However, while inflation has trended lower recently, interest rates are historically high. Economists anticipate the economic fallout from the Fed’s tight monetary policy measures may intensify in 2024.
Investors are hopeful the Fed will be able to navigate a so-called soft landing for the U.S. economy and avoid a severe recession in 2024. Unfortunately, inflation remains well above the Fed’s 2% long-term target, and experts are divided on whether the Federal Reserve may have simply delayed an inevitable recession.
The Federal Reserve itself projects its monetary policy tightening measures will weigh on U.S. economic growth in 2024.
Fortunately, the Fed recently modified its economic projections and no longer anticipates a U.S. recession. While the risk of a severe recession has declined in 2023, economists and analysts anticipate interest rates will remain higher for longer than optimistic Americans had hoped.
Investors looking ahead to 2024 should consider taking a cautious approach to their finances given the potential for a slowdown in gross domestic product growth, sticky inflation and a delayed negative economic impact from the Fed’s aggressive rate hikes.
Economic outlook for 2024
There’s no question the U.S. economic outlook has improved throughout 2023, but that doesn’t necessarily mean the economy is in the clear heading into 2024.
The U.S. recorded 2.2% GDP growth in the first quarter of 2023 and 2.1% growth in the second quarter. As for its latest projections, the Fed expects the economy to roughly maintain that growth pace in the second half of 2023, forecasting full-year GDP growth of 2.1%. The Fed predicts GDP growth will slow to just 1.5% in 2024, a modest but positive pace.
The labor market also remains resilient heading into the end of the year. The unemployment rate has risen to just 3.8%, and the economy has averaged more than 250,000 jobs created per month over the past three months. The Federal Open Market Committee projects the U.S. unemployment rate will average a healthy 4.1% in 2024, still well below its long-term average of around 5.7%.
Unfortunately, some economists are skeptical that the U.S. can maintain economic growth with interest rates so high. The Conference Board predicts U.S. GDP growth of just 0.8% in 2024, including a “shallow recession” in the first half of the year. The nonprofit research group said wage growth is slowing, pandemic savings are declining and U.S. household debt is spiking.
The COVID-19 pause on student loan payments ended in October, placing an additional financial burden on millions of Americans. As a result, The Conference Board projects real U.S. consumer spending will drop 1.1% in the first quarter of 2024 and decline 1% in the second quarter annually. The firm said softening consumption, coupled with rising interest rates, will also weigh on U.S. business investment in early 2024.
The Fed’s inflation target
The FOMC has been aggressively raising interest rates since March 2022 with one goal: controlling inflation. So far, the Fed’s policy measures have worked extremely well, but its job still needs to be finished heading into 2024.
The Federal Reserve’s preferred inflation measure is the core personal consumption expenditures price index, or core PCE. The core PCE measures U.S. shoppers’ prices for goods and services, excluding volatile food and energy prices.
The Fed has a long-term core PCE inflation goal of 2%. But core PCE inflation surged as high as 5.3% in February 2023. As of August 2023, annual core PCE inflation was down to just 3.9%. That said, it remains nearly double the Fed’s 2% target.
Looking ahead to 2024, the FOMC projects core PCE inflation will continue to improve and average just 2.6% next year and 2.3% in 2025.
Inflation is typically a symptom of an overheating economy, so the Fed has been raising interest rates to bring down inflation without cooling the economy so much that it begins to contract.
Brad McMillan, chief investment officer at Commonwealth Financial Network, said the Federal Reserve deserves credit for its performance up to this point.
“With job growth strong and other data supportive, those higher rates seem to be bringing inflation down successfully without tanking the economy,” McMillan said. “This is the elusive soft landing that everyone has been hoping for but which very few thought would really happen. Of course, we are not there yet.”
Alternatively, a hard landing for the economy would likely be bad news for stock prices and U.S. workers.
For example, when the FOMC raised fed fund rates to more than 19% in 1981 to combat inflation, it triggered a severe 16-month recession. Subsequently, that launched a nearly two-year bear market for stocks and sent unemployment up to 10.8%.
Are more rate hikes expected in 2024?
Since March 2022, the FOMC has raised its fed funds interest rate target range by 5.25% to its current level of between 5.25% and 5.5%. Interest rates are now at their highest level in 22 years.
The bond market is pricing in more than a 40% chance of another rate hike by the end of 2023 and a more than 25% chance the Fed will cut interest rates below their current level by May 2024, according to CME Group.
Bill Adams, chief economist for Comerica Bank, said surprising increases in housing prices could fuel further shelter inflation in 2024. But rising long-term U.S. Treasury yields could help make additional Fed rate hikes unnecessary.
“Either way, the path is clearer for the Fed to pivot to rate cuts in mid-2024 with wage growth slowing, core inflation head(ing) lower and gasoline futures prices at year-to-date low(s),” Adams said.
Looking further into the future, the FOMC projects the fed fund rate will fall to an average of 3.9% in 2025 and 2.9% in 2026. But investors shouldn’t rely too heavily on these extremely long-term projections given how much economic circumstances could change between now and then.
Can we expect a recessionary environment in 2024?
While there is no official government definition for an economic recession, economists typically consider at least two consecutive quarters of negative GDP growth to be a recession. The Fed is no longer forecasting a prolonged U.S. recession, and economists from Bank of America agree.
But the ratio of the 10-year yield to the 2-year yield curves in U.S. Treasurys has been inverted since mid-2022, and an inverted yield curve has historically been a strong indicator a recession is likely.
The New York Fed’s recession probability model suggests a 56.12% chance of a U.S. recession by September 2024.
Richard Saperstein, chief investment officer at Treasury Partners, said the positive performance of the stock market in 2023 may have lulled Americans into a false sense of economic security heading into 2024.
“There are elevated expectations for a bullish slowdown where the economy slows enough to bring down inflation but not enough to trigger a recession,” Saperstein said. “Stocks are facing headwinds from higher interest rates and the uncertainty of how higher rates will affect economic growth and earnings.”
Americans concerned about a potential recession in 2024 should continue monitoring the Labor Department’s monthly jobs reports, typically released on the first Friday of each month. As long as the economy continues adding jobs, GDP growth will unlikely drop into negative territory, experts say.
While a growing number of economists are optimistic about a potential soft landing in 2024, there are plenty of risks to the U.S. economy in the next 12 months.
The most obvious risk is the one the FOMC identified, and it’s made targeting inflation a top priority for nearly two years.
If it becomes clear at any point that inflation is no longer trending lower in 2024, the Federal Reserve will likely have no choice but to respond with even more interest rate hikes. And that would put additional pressure on corporate earnings and economic growth. Higher interest rates increase borrowing costs for consumers and corporations, reducing spending and investment and slowing economic growth.
But even if inflation continues to trend lower, the FOMC will need to time its pivot from rate hikes to rate cuts perfectly to avoid either a rebound in inflation or a sharp drop in economic growth that could lead to a recession. The Fed is attempting to thread the needle and achieve a soft landing. But even one major misstep by the central bank could be enough to send the economy spiraling.
Financial pressures such as student loan repayments, slowing wage growth and rising household debt may negatively impact consumer spending in 2024, especially if Americans completely burn through their pandemic-era savings. Rising credit card debt levels when interest rates are already at multidecade highs could also hurt consumer sentiment and spending.
Finally, geopolitical risks are always a wild card for the economy, especially in a U.S. presidential election year like 2024. The ongoing conflict in Ukraine and the recent outbreak of war between Israel and Hamas in the Middle East could have a significant impact on international financial markets and the global economy.