Fed March 2024 quarter projections bets on higher growth
FED QUARTERLY PROJECTIONS UPS GROWTH AND PCE INFLATION
Along with the Fed policy statement on March 20, 2024, the Fed also updated its quarterly projections of key macros. The Federal Open Markets Committee (FOMC) gives a quarterly update of key projected macros like GDP growth, core PCE inflation, headline PCE inflation and unemployment. In addition, it also provides the guidance on how the Fed rates would pan out in the next few years. The big change in March 2024 update was that we now have full year data for calendar 2023 and projections for 2024, 2025 and 2026; apart from the long range sustainable projections. There were 3 trends visible in the latest macro update.
The first change is obvious. The FOMC has upped the GDP growth estimate for FY24 to 2.1% now, after calendar 2023 GDP growth came in sharply higher at 3.1%. GDP growth is now likely to be 2% or higher till calendar 2026. Secondly, the Fed has upped the core PCE inflation projections by 20 bps for calendar 2024. That is likely on the back of the shipping crisis globally, which could disrupt supply chains in 2024. Long term PCE inflation remains static. Finally, the rate cuts are still on, but the Fed has toned down its projections on rate cuts. The Fed will move in a more calibrated fashion on rate cuts.
US MACRO STORY FOR LAST 5 CALENDAR YEARS
Here is a quick recap of the data points of the last 5 years. These are actuals and based on actual data flows. It has been updated for actual 2023 data also.
Variable CY-2019 CY-2020 CY-2021 CY-2022 CY-2023 Real GDP Growth 3.2% -1.1% 5.4% 0.7% 3.1% Unemployment Rate 3.6% 6.7% 4.2% 3.6% 3.8% PCE Inflation 1.4% 1.2% 5.9% 5.9% 2.8% Core PCE Inflation 1.5% 1.4% 4.9% 5.1% 3.2%
Data Source: US Federal Reserve (CY refers to calendar year)
What do we read from the table of historic variables. Let us start with the real GDP first. GDP had been consistently over 3% till 2019. After 3 years of tumult and volatility, year 2023 was the first occasion when full-year GDP growth crossed 3% once again. We are ignoring the 2021 growth, as it was on an artificially low base of the COVID period. Unemployment rates fell from a high of 6.7% in CY2020 to 3.8% in CY2023. This is at par with pre-COVID years and close to the definition of full employment at 3.5%. The low employment ratio is on the back of demand for workers sharply higher than supply. On the inflation front, higher rates is having an impact. After averaging 5.9% in 2021 and 2022, the headline PCE inflation has more than halved to 2.8% in calendar 2023.
RECAP – DECEMBER 2023 FOMC PROJECTIONS (VERSUS SEPTEMBER 2023)
Typically, the Fed projections undergo updates every 3 months. Let us first do a quick recap of how the December 2023 FOMC projections of various macro variables changed over the previous September 2023 quarter. This will form the basis for the latest update of March 2024. With CY2023 actual data now out, the projections are focused on CY2024, CY2025 and CY2026. In addition, the long term sustainable projection for each variable has also been updated. Here are the December 2023 versus September 2023 projections.
Variable CY-2024 CY-2025 CY-2026 Longer run Change in real GDP (Dec-23) 1.40 1.80 1.90 1.80 September projection 1.50 1.80 1.80 1.80 Unemployment rate (Dec -23) 4.10 4.10 4.10 4.10 September projection 4.10 4.10 4.00 4.00 PCE inflation (Dec -23) 2.40 2.10 2.00 2.00 September projection 2.50 2.20 2.00 2.00 Core PCE inflation (Dec -23) 2.40 2.20 2.00 September projection 2.60 2.30 2.00 Federal funds rate (Dec -23) 4.60 3.60 2.90 2.50 September projection 5.10 3.90 2.90 2.50
Data Source: US Federal Reserve (CY refers to calendar year)
What did we read from the comparison of the FOMC long term projections for the December 2023 quarter versus the September 2023 quarter?
Let us start with GDP growth projections for coming years. In December 2023, the real GDP was projected to growth at just 1.4% compared to 1.5% in September 2023. The lower GDP growth projection was on the back of the lag effect of the rate hikes, which was expected to impact the GDP growth in a significant way. Let us turn to the unemployment projections for the coming years. For the current year CY2024, the unemployment rate is expected at 4.1%. This is likely to be largely helped by demand for jobs exceeding supply of jobs in the US market as labour market still remains tight. However, the unemployment rate is higher than the 3.8% levels seen in 2023. While unemployment is likely to stay elevated at 4.1% for the next 3 years, the long term unemployment is likely to veer towards 4.0%. This should be seen as a comfortable level. If you compare the December projections with the September projections, there is not much of a change on the jobs front. The higher unemployment projection in 2024, compared to 2023 is due to likely impact of monetary tightness and Fed hawkishness. Let us turn to the PCE inflation and the core PCE inflation projections for the coming years. Compared to the September 2023 projections, the December 2023 projections saw slightly lower PCE inflation and core PCE inflation being factored in. That is because; the original estimate was that the core inflation could take longer to taper, but it has picked up momentum in the second half of 2023. That is reflected in these projections. As per the December projections, both the headline PCE inflation and core PCE inflation have seen their projections being lowered. How did all these macros impact the Fed rate projections in December 2023 quarter? First a quick background to this. In the October policy statement, the Fed had for the first time indicated that rates had peaked out and that it would embark on aggressive rate cuts. The Fed had also projected 75 bps rate cut in 2024 and another 100 bps in 2025. That euphoria was reflected in the December projections. As a result, the December projections saw Fed Fund rate estimates come down sharply by 50 bps for CY2024 and by 30 bps for CY2025. However, the projections for Fed Funds rate for CY2026 remained static, even as the long rang rates have been maintained at 2.5%.
As of December, the Fed was still running with assumption of 75 bps rate cut in 2024 and another 100 bps in 2025. However, the latest data suggests that the rate cuts in 2025 may be lower and there is still ambivalence on when rate cuts will commence in 2024. For now, the debate is a lot more hypothetical, till the time the Fed actually bites the bullet on rate cuts. That may be a good 3-4 months away.
PRESENT DAY – MARCH 2024 FOMC PROJECTIONS (VERSUS DECEMBER 2023)
In the previous segment, we spoke about estimates made by the Federal Open Markets Committee (FOMC) at the time of December Fed statement and compared it to the September projections. Now we have the latest updates for March 2024 and so look at a comparison of the various macro projections as updated in March 2024 compared to December 2023. This is part of the routine quarterly updated and the key changes in outlook are visible in GDP growth, core PCE inflation and unemployment rates.
Variable CY-2024 CY-2025 CY-2026 Longer run Change in real GDP (Mar-24) 2.10 2.00 2.00 1.80 December projection 1.40 1.80 1.90 1.80 Unemployment rate (Mar-24) 4.00 4.10 4.00 4.10 December projection 4.10 4.10 4.10 4.10 PCE inflation (Mar-24) 2.40 2.20 2.00 2.00 December projection 2.40 2.10 2.00 2.00 Core PCE inflation (Mar-24) 2.60 2.20 2.00 December projection 2.40 2.20 2.00 Federal funds rate (Mar-24) 4.60 3.90 3.10 2.60 December projection 4.60 3.60 2.90 2.50
Data Source: US Federal Reserve (CY refers to calendar year)
Here are some of the key takeaways from the FOMC long term projections for the December quarter, pertaining to the likely guidance on macros for next few years.
Let us first talk about the GDP growth projected for the coming years. For the current year CY2024, the real GDP is expected to grow by 2.1%. This is likely to be largely helped by lower retail inflation. The CY2024 projection of GDP is a good 70 bps above the December projections. However, with CY2023 GDP growth coming in robust at 3.1%, further upsides to these estimates cannot be ruled out. Let us turn to GDP growth projection for subsequent years beyond CY2024. The GDP growth for CY2025 has been upped by 20 bps while the GDP growth projections for CY2026 has been upped by 10 bps in the March 2024 projections as compared to the December 2023 projections. However, the long term sustainable GDP growth has been maintained at the level of 1.80%. The thrust to GDP is likely to come from higher consumer spending and with lower inflation giving a boost to real GDP growth. Let us turn to the unemployment projections for the coming years. For the current year CY2024, the unemployment rate is expected at 4.0%. This is likely to be largely helped by demand for jobs exceeding supply of jobs in the US market as labour market still remains tight. However, the unemployment rate for 2024 was projected at 4.1% in December 2023. For subsequent years, the rate of unemployment at 4.10% and 4.00% respectively. Let us turn to the PCE inflation and the core PCE inflation projections for the coming years. For the current year CY2024, the March 2024 updated suggest PCE inflation static at 2.4%. This is being lowered to 2.2% and 2.0% in calendar years 2025 and 2026 respectively. Interestingly, the core PCE inflation for 2024 has been upped by 20 bps in March 2024 estimates as compared to the December 2023 estimates. That could be due to the lag effect of the Middle East crisis and its impact on energy prices. In the latest inflation readings, most of the pressure on core inflation has come from oil related items like car maintenance, auto insurance, transport, and air fares. What do all these macros mean for the Fed rate projections for the next few years? The December projections showed a lot of enthusiasm and euphoria that rate cuts would be rapid and front-ended. However, in the subsequent months, there has been a reality check from inflation, the rate inflation has been sticky and that has forced the Fed to do a rethink on the pace of rate cuts. It has already reduced the rate cut assumption from 4 rate cuts to 3 rate cuts in 2025, although the Fed still sticks to 3 rate cuts in the second half of 2024. One message is that the rate cuts will happen at a lower rate in 2025 and 2026, which is evident from the Fed rate projections in these years being upped by 30 bps and 20 bps respectively.
Broadly, there are 3 levels of changes that we can decipher from the March 2024 projections of US macros compared to the December 2023 macros. GDP growth is being projected higher, unemployment is being projected lower and core PCE inflation is likely to be the pressure point in CY2024. However, the longer term projections are largely unchanged in the March 2024 update.
HOW WILL RBI INTERPRET FOMC PROJECTIONS UPDATE OF MARCH 2024
There are clear positive takeaways from the macro projections in March 2024. Firstly, the GDP growth projections for 2024 have been sharply upped by 70 bps, but if you consider the 3.1% growth in 2023, then there could be more positive surprises. The unemployment rate has also been lowered. While the unemployment is still off the 3.5% mark, it is not picking up as quickly as originally anticipated. However, the one thing to focus on is the higher than expected core PCE inflation this year. For the RBI, the message is that the Fed would be in no hurry to herald rate cuts and it would still be data driven. For the RBI, the first action point will be after the full budget in July 2024.
