The key points you should know:
- This is what a soft landing looks like.
- Economic growth, especially the job market, is slowing – but not dangerously so.
- Inflation continues to slow but is still modestly above the Fed’s longer-term goal.
- The Federal Reserve has begun to ease and expects to ease further this year and next.
The broadest measure of economic growth, real GDP, accelerated in the second quarter, up to an annualized pace of 3.0 percent. Because the quarterly data can be volatile, the four-quarter growth rate is a better way to see trend growth. For the past two years, this trend growth has averaged between 2.5-3.0 percent – and that’s what the most recent data show.
- “Core” growth (real final sales to private domestic purchasers) edged down a tad to an annualized rate of 2.7 percent. As with overall GDP, the four-quarter average is a better way to view underlying growth – and this came in at 2.9 percent. No sign of recession here.
- The Atlanta Fed’s GDPNow estimate of third quarter real GDP growth is 3.1 percent. This is an early view into the current quarter and may change significantly before the official data are released – but for now it shows that the economy continues to grow at a modest rate (and perhaps a bit faster than trend).
But despite overall economic activity running a bit above most estimates of trend growth, important parts of the economy continue to slow and/or disappoint.
- Housing activity continues to be weak, with starts and sales (especially of existing homes) running well below their post-Covid peaks. A combination of higher mortgage rates and lack of supply (too many current homeowners are unwilling to sell with historically low mortgage rates on their current homes) continue to push house prices higher and hit affordability. Even with the recent decline in mortgage rates (and likely further declines in coming months), additional increases in demand will be offset by the lack of supply and will likely result in an acceleration of house price gains – keeping sales in check.
- The ISM manufacturing survey has been below the break-even level of 50 for most of the past year, and the most recent data point of 47.2 percent for September continues to show that the sector is slowing.
- The NFIB small business optimism survey dropped to 91.2 in August, the 32nd consecutive month that it has languished below the 50-year average of 98.
Offsetting these weaker sectors, consumer spending remains solid – with the 12-month trend growth rate of personal consumption expenditures edging higher to 2.9 percent for August. Given that consumer spending makes up nearly 70 percent of all spending in the economy, substantial slowing of real GDP growth will be unlikely unless consumers take a breather.
While overall economic activity has been little changed, the job market is clearly slowing. Nonfarm payroll gains slowed sharply in the first two months of the third quarter, with July showing a rise of only 89,000 before rebounding a bit in August to 142,000. The U-3 unemployment rate has trended higher from its low of 3.7 percent in January, reaching 4.3 percent in July – before slipping a bit to 4.2 percent in August. While these data are weaker, they are not weak in an absolute sense, and the weekly unemployment claims remain low (and have even slipped a bit over September).
A combination of tighter monetary policy and significantly fewer supply constraints is bringing inflation lower. The Fed’s preferred inflation measure, the price index for personal consumption expenditures (PCE) dropped to 2.2 percent in August from a year earlier – near the 2.0 percent long-term goal. Even the core PCE price index (removing the volatile food and energy components) was up by only 2.7 percent over the 12 months ending in August.
The Fed responded to the slowing of the labor market and inflation moving closer to its 2.0 percent goal by cutting the federal funds rate by 50 basis points (bps) at the September FOMC meeting. Moreover, the most recent projections by FOMC members show that most of them expect to cut by another 50 bps before the end of this year, and by another 100 bps in 2025. Market interest rates had already dropped in expectation of Fed easing, although short-term rates fell further on the actual event. The yield on the 10-year Treasury note was at 3.79 percent at the end of September, up a bit from its recent lows but down substantially from its recent high in October 2023. After inverting in July 2022, the spread between the 10-year and 2-year Treasury notes finally regained its usual upward slope at the start of September (although shorter-term rates still remain above the 10-year Treasury yield). If inflation moves lower, the economy slows further, and the Fed eases as it expects, the entire Treasury yield curve should un-invert over the course of 2025.
Equity markets have rallied in the face of easier credit conditions, expectations of more Fed easing (and lower interest rates), slower inflation, and continued modest economic growth (implying further corporate profit gains). The S&P 500 Index, for example, closed September at around an all-time high, while other broad stock market indices were also at lofty levels.
David W. Berson, Ph.D.
Chief US Economist
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