With inflation normalising due to improving supply, the Fed is in the fortuitous position of being able to lower interest rates even though economic growth remains solid and the unemployment rate is still relatively low. Despite the downshift in employment growth, we expect GDP growth to remain strong over the next couple of years, as monetary policy rapidly shifts from a headwind to a tailwind. The presidential election adds to the uncertainty. We are worried that tariffs and immigration curbs imposed in a second Trump administration could be stagflationary. 

• With inflation normalising due to improving supply, the Fed is in the fortuitous position of being able to lower interest rates even though economic growth remains solid and the unemployment rate is still relatively low. Despite the downshift in employment growth, we expect GDP growth to remain strong over the next couple of years, as monetary policy rapidly shifts from a headwind to a tailwind.
• Third-quarter GDP growth is tracking at 2.5% annualised, principally thanks to the strength of consumption growth. (See Chart 1.) Although their excess savings accumulated during the pandemic appear to be all-but exhausted, households are still benefitting from low pandemic-era fixed mortgage rates, which mean debt servicing costs remain muted. Higher-income households are also receiving a boost from wealth gains stemming from the stock market boom.
• Admittedly, the pick-up in credit card and auto loan delinquencies suggests that lower-income households are struggling a little, but the most-recent drop back in energy prices should provide some relief. (See Chart 2.)​

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• The pace of employment growth has slowed, and the BLS has indicated that the monthly gains over the last 18 months will ultimately be revised lower. Nevertheless, rather than continuing to deteriorate, we expect those monthly gains to stabilise at around 100,000. (See Chart 3.)
• Assuming that the recent sharp slowdown in unauthorised immigration is sustained, (or even becomes more pronounced if Donald Trump wins this November’s presidential election), then that slower pace of employment growth won’t necessarily translate into a rising unemployment rate. We expect it to peak at 4.5%. (See Chart 4.)​

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• We also expect a modest cyclical slowdown in productivity growth over the next 12 months, before a more pronounced AI-related structural pick-up takes effect from 2026 onwards. (See Chart 5.) Our optimism over productivity growth is the key reason why we expect GDP growth to accelerate without triggering any meaningful rebound in inflation. (See Chart 6.)​

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• Core PCE price gains have slowed again to a target-consistent 2% annualised pace. Prices increased at a similarly muted pace in the second half of last year, however, so the annual core PCE inflation rate will remain close to 2.5% until early next year, when it will rapidly fall to 2% or even slightly below target.
• With inflation all-but vanquished, we expect the Fed to cut interest rates to between 3.00% and 3.25% next year. (See Chart 7.)
• Our forecasts are based on an assumption of policy continuity but, particularly if Donald Trump wins the presidential election, we would expect to make changes. We explain here why we think Trump’s plans for tariffs and curbs on immigration would subtract 0.8% from real GDP and add 1.2% to the price level.
• Regardless of who wins, we don’t expect any major fiscal stimulus. With the Federal deficit already running at more than 6% of GDP, partly because debt servicing costs are rising, and the debt burden approaching 100% of GDP, we suspect any plans for additional stimulus would be met by an adverse market reaction. (See Chart 8.)

Capital Economics clients get the full analysis, including:

• Why we expect a modest slowdown in non-farm payroll growth and think falls in employment are unlikely, while softer labour force growth means the unemployment rate will peak at 4.5%.
• How we are confident inflation will fall to 2% by early 2025, and then drop even slightly below target. Also why we expect core PCE inflation to end this year at 2.5%, before it falls rapidly to 1.8% in spring next year.
• Why, after starting its loosening cycle with a bang, we expect the Fed to take a more measured approach to cutting interest rates from now on, with a 25bp cut coming at each meeting until rates have fallen to between 3.00% and 3.25% next year. By that time, we expect accelerating GDP growth to dissuade the Fed from cutting rates below that neutral level.
• What this November’s elections could mean for our forecasts, particularly if Donald Trump is elected and follows through on his pledges to impose draconian restrictions on immigration and introduce a universal tariff and prohibitive tariffs on goods from China. 

This is a sample of the 13-page US Economic Outlook prepared for Capital Economics clients, published on 23rd September 2024 and written by Paul Ashworth, Stephen Brown, Olivia Cross, Thomas Ryan, Bradley Saunders and Ruben Abargues.