U.S. Quarterly Economic Forecast

And Now, The Hard Part

Date Published: September 19, 2023

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  • Inflation remains the hottest topic in the global outlook. Inflationary pressures are cooling across the G-7, but progress on core measures has proved more difficult, leaving central banks’ bias towards additional rate hikes.     
  • The substantial monetary tightening already working its way through the economy is projected to slow the pace of global expansion from 3.1% this year to 2.7% in 2024.  In 2025, a modest pickup to a still-sluggish 2.9% rate is anticipated.  
  • The U.S. economy – which has been a standout in terms of resilience this year – is set to see growth slow from 2.3% in 2023 to 1.3% in 2024.  That would still leave the U.S. in top spot in the G-7 growth tables and marks a half-point upgrade from forecast in June.  As such, the odds of another rate hike are a coin toss at this stage, while the prospect of cuts has been pushed back even further into next year relative to our prior view.

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Chart 1 titled

Recession calls have been pared back in recent months as advanced economies weather the substantial monetary tightening of the past 18 months better than many forecasters feared. Hopes that the U.S. Federal Reserve will pull off a soft landing have increased, with markets building in expectations that interest rates will remain higher for longer. But now comes the hard part. Most forecasters – including ourselves – continue to call for a period of subdued growth with rising unemployment. Weaker labour markets are necessary to help bring persistently high services inflation back down to acceptable levels. So, the distinction between a soft landing and a recession will likely be cold comfort for many consumers and businesses who will increasingly feel the pinch.   

The good news is that inflation continues to cool across the G-7 as the energy price shock from 2022 fades in the background (see latest inflation tracker). Core inflation watched by most central bankers is another matter, with the deceleration in Canada and the U.S. not mirrored in Europe or the UK (Chart 1). Central bankers will need to continue to talk tough on the possibility of further rate hikes, but most are at the fine-tuning phase of the rate hiking cycle. 

China is the odd one out as economic growth disappointed in the second quarter. Although most forecasts were upgraded for the advanced economies in 2023, China’s outlook went in the other direction with a downgrade (see Table).  

However, next year will remain a challenge for all economies. As the long-and variable lags from past interest rate hikes come to bear, a period of below-trend growth is likely to be sustained. The debate over soft landing or recession will rage on. 

U.S. to slow as countercyclical buffers wear thin 

Chart 2 is titled Modest Rise in the Unemployment rate and shows the U.S. and Canadian unemployment rates going back to 1990, through 4 previous U.S. recessions. It also shows a forecasted rise in the unemployment rates over the next two years which is reasonably modes relative to past recessions.

So far in 2023 the U.S. economy has seemed almost impervious to higher interest rates, turning in a solid 2% pace of growth. In normal times that is not much to write home about, but after 18 months of relentless rate hikes, high inflation, and banking turmoil, it is notable. Not to mention that growth in the third quarter is likely to blow the roof off with an impressive performance of around 4%, courtesy of a resilient consumer (Chart 2). However, we are now approaching the point where many special influences will be fading. Not to mention the potential headwinds from a prolonged UAW strike and government shutdown.    

Top of that list is the depletion of pandemic-related excess savings by year end, a countercyclical force that helped consumers weather high inflation and interest rates rather well. In addition, households will enter 2024 with a savings rate at half its pre-pandemic level, while the repayment of student loans simultaneously comes back into scope. 
Job availability is also becoming less plentiful, and this trend will become more exaggerated next year. Hiring has averaged 150 thousand jobs per month over the past three months, half the pace at the beginning of the year. We anticipate this trend will shift to net job losses by over the coming quarters leading to a one percentage point increase in the unemployment rate.  

Fiscal supports will also lessen next year. When Congress suspended the debt ceiling earlier this year, they agreed on a 1% automatic spending cut if annual spending bills are not passed by the end of September. At time of writing, Congress has yet to pass the necessary spending bills, and a government shutdown cannot be ruled out. Wherever the dust settles on a spending resolution, it is likely to contain further compromises on spending initiatives. 

However, supporting a soft-landing narrative is that households, in general, lack the excess leverage that historically sets the economy into a tailspin during high interest rate periods. And on the business front, past government initiatives via the CHIPS & Science Act and the Inflation Reduction Act will still be leaving their counter-cyclical mark on investments for green energy and semiconductor facilities (see our report). In addition, new infrastructure money from Washington and healthy State finances have also pushed combined government investment spending growth over the past year to the fastest pace in more than 20 years (and if defense spending is excluded, the fastest pace in over 30 years).  

Putting the pieces together, inflation should continue to move in the right direction as pressures lessen on the consumer side. On a three-month annualized basis, the core PCE deflator – the Fed’s preferred inflation metric – has already dropped below 3% in July. But we are not out of the woods yet. Super-core inflation, which encompasses services excluding housing, is the more sensitive measure that captures wage pressures, and this has recently begun to heat up again. This underscores the Fed’s need for vigilance, and why it is likely to maintain its hawkish tone, even as the economy cools. We think the Fed is near the end of its rate hike cycle, but caution that the likelihood of another rate hike is close to a coin toss at this point. The data will need to cooperate in a convincing manner, which ultimately boils down to weaker employment and inflation trends.       

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Contributing Authors

  • Beata Caranci, Chief Economist | 416-982-8067

  • Derek Burleton, Deputy Chief Economist | 416-982-2514

  • Leslie Preston, Managing Director | 416-983-705

  • Thomas Feltmate, Director | 416-944-5730

  • James Orlando, CFA, Director | 416-413-3180

  • Andrew Hencic, Senior Economist | 416-944-5307