US - Headwinds are building
Growth looks set to slow sharply in Q4. Even without a government shutdown, the restart of student loan repayments and slowing jobs growth are likely to weigh on consumption. The labour market has cooled significantly. This is helping to dampen wage growth, making it likely that disinflation will resume once the near-term inflation bounce is behind us. We continue to expect rate cuts next year, but policy will stay in restrictive territory until 2025.
The cruising US economy is about to enter choppier waters. The most immediate risk is of a government shutdown. If Democrats and Republicans cannot reach a compromise to pass the president’s budget by the end of September, parts of the government will suspend activity and hundreds of thousands of workers will be furloughed – something that last happened in late 2018. At the time of writing, betting markets put the odds of a shutdown at 69%, and the rule of thumb is that a shutdown would lower quarterly annualised GDP growth by around 0.2pp for each week the government is closed (the most recent shutdown lasted 5 weeks). While much of this negative impact would be unwound once a deal is struck, it would come alongside a number of headwinds which, taken together, could drive a contraction in output in Q4. One is the restart of student loan repayments, as the pandemic era moratorium comes to an end. Another is the United Auto Worker (UAW) strikes, which could hit output in the sector just as it recovers from pandemic-related supply chain disruptions. We in any case expect growth to slow sharply in the Q4, with a rising savings rate and slowing jobs growth expected to weigh on consumption. These additional headwinds could tip that into an outright decline in GDP, particularly after what is shaping up to be a strong Q3 (the Atlanta Fed’s GDPNow tracker for Q3 stands at 4.9% q/q saar, partly driven by higher inventories).
Elsewhere, the economy is showing signs of slowing. Q2 GDP was revised down to 2.1% from 2.4% on the back of weaker business investment, and although jobs growth for August was broadly in line with expectations, there were significant downward revisions to previous months. All told, the pace of jobs growth has more than halved in the year to date, with the 3 month average falling from around 330k at the beginning of 2023, to just 150k as of August. Over the same time period, job vacancies have fallen by nearly 2 million, and the ratio of job vacancies to unemployed people has fallen to 1.5 – still on the high side, but now not far above the pre-pandemic level of 1.2. This broad easing in labour market tightness has helped dampen wage growth, with various wage growth measures now cooling rapidly. Given that wage growth is the main driver of the medium term inflation outlook, we expect the broad disinflation trend to resume once the near-term (oil-driven) rebound in inflation is behind us (see this month’s Global View).
For now, the Fed continues to strike a hawkish tone given the resilience in the economy, and the fear that inflation may not fall fully back to target. We remain unconvinced that the Committee will follow through with a further rate hike, as signalled in last week’s projections. Financial markets are currently split on the issue, with around a 50% probability of one last hike priced in. Once the economy more meaningfully slows, and assuming the the labour market slowdown and the broad disinflation continues, we continue to expect the FOMC to pivot to rate cuts from March. Still, rates are likely to remain well into restrictive territory throughout the coming year, with policy returning to neutral settings only in 2025.