The U.S. economy has shown promising growth, but the road to sustained recovery remains uncertain. According to the Bureau of Economic Analysis (BEA), the U.S. GDP grew by 4.9% in the third quarter of 2023, a sharp rise from the 2.1% growth in the second quarter. As a result, I’ve revised my 2023 GDP growth estimate upward from 1.5% to 2.2%. Despite these positive figures, concerns linger over whether such growth is sustainable in the long term.

A Closer Look at the Growth Numbers

The 4.9% growth rate in the third quarter is impressive, but when we dig deeper, much of this growth appears to be short-term. For instance, 1.3% of the growth came from increased inventory accumulation, which is often temporary. Additionally, residential investment and government spending contributed 0.5% and 0.8%, respectively. While government spending might persist over time, it doesn’t necessarily contribute to long-term growth in the economy. Subtracting these short-term factors, we get a growth rate closer to 2.3%, which is more sustainable but still driven by personal consumption.

Inflation Trends and the Fed’s Response

On the inflation front, the news is generally positive. Core PCE (Personal Consumption Expenditures), the Federal Reserve’s preferred measure of inflation, was up 3.7% year-over-year as of September 2023. This marks a decrease from the previous quarter’s 3.7% annualized rate, indicating that inflationary pressures are easing. The Conference Board’s report also shows a drop in core PCE, which has contributed to the Fed’s decision to pause interest rate hikes.

As of the Fed’s November meeting, they opted not to raise rates, which is a positive signal, given the recent improvements in inflation. That said, it’s unlikely the Fed will increase rates again this year unless inflation takes an unexpected turn for the worse.

2024 Outlook: Slower Growth and Inflation

Looking ahead, my forecast for 2024 is a slight slowdown in both GDP growth and inflation. Historically, the U.S. has been in recession about 12% of the time since World War II, and given current trends, the chances of a recession in 2024 appear to be higher than usual. My models still suggest a higher probability of a downturn. However, I don’t foresee an extremely deep recession like the Great Recession of 2007-2009. Instead, if a recession occurs, it should be relatively mild and brief.

If this slowdown materializes, we can expect an uptick in the unemployment rate and a potential contraction in corporate profits. As a result, the Federal Reserve might reduce interest rates, as inflation concerns would likely diminish during a recession.

GDP and Inflation Projections

For 2023, I now estimate real GDP growth at 2.2%, with inflation (core) at 3.8%. Looking ahead to 2024, I expect GDP to grow at 1.5%, with inflation decreasing to 2.5%. The consensus estimates from Wall Street suggest a similar outlook for growth and inflation in 2024.

Factors Contributing to Slower Growth

Several factors are contributing to a slower growth rate in 2024 compared to 2023. First, since the pandemic, consumption has driven a disproportionate amount of economic growth—88% in recent years, compared to a long-term trend of 70%. As personal savings have dwindled from a high of $3.5 trillion to less than $1 trillion, many consumers are feeling the financial strain. Additionally, the rising cost of credit, as credit card debt usage has surged, signals that consumer spending may slow down.

Moreover, with mortgage rates above 8%, the housing market is in a slump. Homeowners with lower mortgage rates are reluctant to move, leading to a lack of housing supply. This stagnant market is further compounded by the fact that average household incomes are insufficient for most potential homebuyers, given current mortgage rates.

Unemployment and Economic Slowdown

I anticipate a slight increase in unemployment in 2024, possibly reaching around 5% by the end of the year. This would place additional pressure on consumer spending growth, further contributing to the economic slowdown.

Final Thoughts on the Economy and Bond Market

While a recession seems possible in 2024, I expect it to be relatively mild, especially compared to the 2007-2010 Great Recession. The economic environment is shifting, with globalization trends slowing down and nationalistic policies taking more precedence. Trade is expected to represent a smaller share of global economic activity than it has in the past, and the era of ultra-low interest rates may be coming to an end.

In terms of government spending, particularly in the U.S., I expect deficits to remain high as governments continue to deal with aging populations and rising debt levels. This trend will likely keep interest rates higher than they have been over the past decade.

On the bond market front, I’m adopting a more positive outlook. The 10-year U.S. Treasury note, with a 5% yield, now offers a “real” return of 2%, which is the average return over the past 50 years. This development is encouraging for fixed-income investors.

Conclusion

Although the U.S. economy is showing growth, it’s important to recognize that much of the recent GDP increase is driven by short-term factors that may not be sustainable. Inflation is trending down, and the Fed has paused rate hikes, but uncertainty about the future remains. A mild recession in 2024 is possible, and if it materializes, it could pave the way for a more sustainable economic recovery.