Regional Market Summary Q4 2023

Threading the Needle: High interest rates impacting economic activity; relief expected by summer

Quarterly Market Report Q4 2023

Written by Bill Polley, Ph.D., Director of Business Intelligence, Quad Cities Chamber

After several quarters of lackluster GDP growth, the U.S. economy finished 2023 with two very strong quarters that provided a nice upside surprise to GDP. In the fourth quarter, real GDP increased at a seasonally adjusted annual rate of 3.3%. This comes on the heels of a 4.9% increase in the third quarter. At the time of our last Quarterly Market Report (mid-November), the Federal Reserve Bank of Atlanta’s GDPNow forecast was predicting a 2.1% increase for the fourth quarter. Once again, the actual number came in better than the forecast.

Consumer spending was the largest contributor to the increase in GDP, contributing 1.91 out of the 3.3% increase. Fixed investment spending (excluding the change in inventories) slowed markedly, contributing only 0.31% - the lowest contribution of fixed investment in 2023. Net exports and government purchases contributed 0.43 and 0.56% respectively.

While most (though not all) forecasters are no longer predicting a recession in the next year, the consensus forecast is still for a slowdown as we move into the middle of this year. As of this writing (week of Feb. 19, 2024), the Blue Chip consensus forecast is just under 2% for the first quarter of 2024. However, the Atlanta Fed’s GDPNow forecast is predicting a 2.9% increase, a full percentage point above the Blue Chip consensus. Over the last two quarters, GDPNow has consistently predicted higher than the Blue Chip consensus, and actual GDP has exceeded even the GDPNow forecast.

While these numbers are good, it is likely that as inflation continues to fall that real GDP growth will fall below 3% and possibly under 2%, if not in the first quarter, then probably in the second. A gradual slowdown would give us the "soft landing" we have been anticipating all last year. However, as we discussed in the last Quarterly Market Report, the risk of policy error is still present. As the economy slows down, the Fed's job becomes more difficult as they try to thread the needle--navigating between the twin goals of price stability and full employment. Waiting too long to lower interest rates risks slowing the economy too much. Lowering rates too early risks re-igniting inflation.

Fourth quarter growth above average

Source: U.S. Bureau of Economic Analysis. Gross Domestic Product (First Estimate).

Inflation decreases significantly in the fourth quarter

In our last Quarterly Market Report, we noted that the inflation rate measured by the personal consumption expenditures (PCE) price index—the Fed’s preferred measure of inflation—was 3.4% in September. During the fourth quarter, the PCE inflation rate was down to 2.9% in October and 2.6% in November and December. This is very encouraging progress.

An important aspect of fighting inflation is ensuring that the public’s expectations of future inflation remain well-anchored. One of the reasons that the inflation fight of the late ‘70s and early ‘80s led to such a severe and prolonged recession was that inflation expectations were slow to adjust. The significance of this event in our economic history is perhaps the main reason why so many people expected a recession last year.

As of December, the median one-year-ahead inflation expectation from the New York Fed Survey of Consumer Expectations was 3.0%. This is only slightly above actual inflation and has been trending down all year as inflation has decreased. This is evidence that the public is well-informed about the Fed’s inflation-fighting efforts, and as a result, businesses have adjusted prices appropriately and employees have set their wage expectations appropriately. The transition from a high-inflation environment to a lower-inflation environment was much faster and smoother than in the late ‘70s and early ‘80s.

Uncertainty about inflation remains elevated, however. The same survey from the New York Fed shows inflation uncertainty still above pre-COVID levels. Broken down by age, it seems that the uncertainty is greatest among young people who have not experienced significant inflation before. Expectations have essentially returned to normal for the Boomer generation which lived through the ‘70s and ‘80s.

As pointed out in our Weekly Economic Trends and Indicators blog, at least some of the remaining inflation will be slow to come down because housing prices and auto insurance rates (just to name a couple of important items) are not as responsive to monetary policy. Even so, expect inflation to continue to slowly move back toward the 2% target over the course of the year.

Local economy slowing ahead of U.S. economy on weaker manufacturing employment

The Quad Cities economy, being more concentrated in manufacturing, has been starting to experience a slowdown ahead of the anticipated national slowdown. The Federal Reserve “Beige Book” summary of economic conditions noted that nearly all districts reported declines in manufacturing, including the Chicago district (where the Quad Cities is located). The Chamber’s Business Outlook Survey in this Quarterly Market Report also shows that local manufacturers perceived a decrease in economic activity in the fourth quarter while non-manufacturers were more positive. However, expectations of the next six months tended to be positive for both manufacturers and non-manufacturers. Leisure and hospitality as well as government were the main drivers of local employment growth in 2023.

Finally, the Weekly State-Level Economic Conditions Index for both Iowa and Illinois experienced a small dip in the quarter but ended near long run levels. This was likely due to the slowing labor market in the quarter

Source: Baumeister, C., Leiva-Leon, D., and Sims, E. (2021). Tracking Weekly State-Level Economic Conditions. Unpublished paper. Notre Dame University, Banco de Espana, National Bureau of Economic Research, and Center for Economic and Policy Research.

Conclusion

Everyone is watching and waiting for the interest rate cuts to begin, but it is not likely to be in the current quarter. Expect rate cuts between May and July. For interest-sensitive sectors such as manufacturing, the rate cuts will be a welcome relief. At the same time, other sectors of the economy are still seeing strong enough growth that rate cuts could re-ignite inflation. This is a critical moment for the Fed as it threads the needle between getting inflation back to its target without hurting the labor market.