Reports from the field confirm the economists’ readings.
“Our members are experiencing a business slowdown, due largely to the effect of increasing interest rates,” says Tom Palisin, executive director at The Manufacturers’ Association, a York, Pennsylvania-based regional employers’ group. “If inflation does not continue to drop, interest rates will have to be increased further, which will be a big problem.”
So, are the Federal Reserve’s efforts paying off? There’s some good news here, as well as a sunny forecast.
Moody’s Analytics expects year-over-year consumer price inflation to average 3.2 percent when 2023 numbers are finally tallied, down from over 6 percent a year earlier. Moreover, the number should continue to drop until it reaches the Fed’s target rate of 2 percent late in 2024.
Indeed, Moody’s Analytics believes the Fed will start to lower interest rates around June 2024, although more slowly than previously anticipated because of persistent inflation and ongoing labor market tightness. Cuts of about 25 basis points per quarter are expected over the next few years until the Federal Funds Rate reaches 2.75 percent by the fourth quarter of 2026 and 2.5 percent in 2027.
Will that de-escalation of interest rates be enough to keep the nation from tipping into a recession? Moody’s Analytics believes the U.S. will avoid a recession in 2024, attributing its forecast of a soft landing to resilience in labor markets and consumer confidence.
Basu, however, is among the economists taking a contrary view.
“I believe the U.S. economy will be in recession by at some point in 2024,” he says. “A number of factors, including a very strong consumer and employers willing to hire more people and raise wages, have allowed the U.S. economy to retain momentum. But major structural issues suggest the economy will weaken, including those higher interest rates.”
Feeling good
The public mood is a strong driver of the economy. And here the news is good.
“Consumer confidence has been trending higher, and I think prospects are good for it to improve next year,” says Scott Hoyt, senior director of consumer economics at Moody’s Analytics. “Things should normalize as the economy continues to grow and gas prices stabilize.”
An impressive level of accumulated debt, though, is hanging like a dark cloud over the consumer landscape.
“With credit card debt now above a trillion dollars, with more consumers having to start paying back student loans and with evidence of slowing labor markets becoming more pervasive, there’s every reason to believe that the pace of consumer outlay growth will soften going forward,” Basu says.
For the immediate future, though, consumer confidence seems secure, due primarily to the healthy job market.
“The unemployment rate has been very low, bouncing around between 3.5 percent and 3.8 percent for some time,” Hoyt says. “We think unemployment will trend upward a bit, ending 2023 around 3.9 percent and 2024 around 4.2 percent.”
Many economists peg an unemployment rate of 3.5 percent to 4.5 percent as the “sweet spot” that balances the risks of wage escalation and economic recession.
Low unemployment may fuel happy sentiments among citizens, but it presents employers with two practical challenges. The first is the need to raise wages to attract sufficient workers.
“Wage and salary income growth has been strong, fueled by a tight labor market,” Hoyt says. “We’re expecting it to increase just a shade over 5 percent both for 2023 and 2024.”
In 2022, the growth was a little over 8 percent.
Reinforcing the estimates of the economists, Palisin says his members have had to increase their compensation to remain competitive among themselves and other economic sectors. The group’s entry level hourly wages increased an eye-popping 8 to 10 percent in both 2022 and 2023, far higher than the historic average of 2.5 to 3 percent.
Problem No. 2 is the ongoing shortage of workers.
“Based on survey data, the No. 1 issue for construction firms continues to be the inadequate supply of skilled workers,” Basu says. “That’s not just a function of the fact that the U.S. economy came screaming out of the pandemic in the form of a V-shape recovery. It’s a long-term, structural, demographic issue that transcends business cycles.
“America simply does not produce enough skilled craftspeople, and this impacts various industries whether energy, manufacturing, logistics or, of course, construction,” he adds. “In the absence of very deep economic downturns, contractors will continue to be scrambling for talent, and that will push wages higher.”
While employers never like having to raise wages, putting a cap on paychecks has taken a back seat to a more urgent concern: keeping valuable talent from jumping ship. Employers are fine-tuning their operations in the areas of workplace flexibility, benefits and culture changes.
“The big question now is not so much who can pay the most for entry-level and skilled jobs, but what can they do to retain these folks within their companies,” Palisin says. “Manufacturing in the U.S. over the last year has continued to hire pretty significantly and we’re not seeing a lot of layoffs, so that tells you that many companies are hoarding talent.”