Fed December 2023 macro projections hint at higher GDP, but lower inflation

17 Dec 2023 , 12:58 PM

When the September macro projections were made by the Federal Open Markets Committee (FOMC), the Fed had pencilled in higher growth rate but inflation was also higher. As a result, the rates were slated to stay higher for a longer period of time. However, there appears to be a sharp change in December 2023 macro projections and the change appears to be for the better. Not only has the Fed further upped the GDP projections for the current calendar year 2023, but it has also cut the inflation forecast for the coming years. 

It may look like a Goldilocks moment for the US economy when the growth rate is higher than expected and the inflation is lower than expected. Despite the aggressive steps taken by the Fed since March 2022 in the form of rate hikes and bond portfolio unwinding; the growth for the third quarter of 2023 is being pencilled in at 5.2%. Clearly, the US economy seems to be showing the kind of momentum, not seen in recent quarters. However, we still need to await data flows in the coming months. Before we get into the projections part, here is a quick recap of the actual data points already announced till date.

Let us start with a recap of key data point actuals

Here is a quick recap of the data points of the last 5 years. These are actuals and based on actual data flows. 

Variable	CY-2018	CY-2019	CY-2020	CY-2021	CY-2022
Real GDP Growth	2.3%	2.6%	-1.5%	5.7%	0.9%
Unemployment Rate	3.8%	3.6%	6.8%	4.2%	3.6%
PCE Inflation	2.0%	1.5%	1.2%	5.7%	5.7%
Core PCE Inflation	2.0%	1.6%	1.4%	4.7%	4.8%

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 consistent under 3% till 2019. It looks like 2023 may be the first agnostic year of pre-COVDI levels of growth. Unemployment rates fell from a high of 6.8% in CY2020 to 3.6% in CY2022. This is not only lower than pre-COVID levels but is also very close to full employment levels, which is defined as 3.5% unemployment. The surge in employment numbers is largely on the back of demand for workers sharply higher than supply. There has been a surge in inflation in the last few years as supply has struggled to keep pace with the surge in demand driven by liquidity. It is not just about food and fuel inflation, but even the sticky core inflation has shown a tendency to surge in the last few years.

Recap – How September FOMC projections changed over June 2023

Let us first do a quick recap of how the September FOMC projections of various macro variables changed over the previous June quarter. We had covered this in our September note, but this recap will help to quickly brush up what the FOMC had estimated back in September and the reasons for the same. It must be noted here that the table below has 4 parts. The first part is the projections of these key macro variables for the next 4 calendar years i.e., CY2023, CY2024, CY2025 and CY2026. In addition, the last column covers the long term sustainable projection for each variable, which is the median rate that is expected to sustain in the long run. Here are the September versus June projections.

Variable	CY-2023	CY-2024	CY-2025	CY-2026	Longer run
Change in real GDP (Sep-23)	2.10	1.50	1.80	1.80	1.80
June projection	1.00	1.10	1.80		1.80
Unemployment rate (Sep-23)	3.80	4.10	4.10	4.00	4.00
June projection	4.10	4.50	4.50		4.00
PCE inflation (Sep-23)	3.30	2.50	2.20	2.00	2.00
June projection	3.20	2.50	2.10		2.00
Core PCE inflation (Sep-23)	3.70	2.60	2.30	2.00
June projection	3.90	2.60	2.20
Federal funds rate (Sep-23)	5.60	5.10	3.90	2.90	2.50
June projection	5.60	4.60	3.40		2.50

 

Data Source: US Federal Reserve (CY refers to calendar year)

Here are some quick takeaways from the September projections of the Federal Open Markets Committee (FOMC) compared to the projections in June; and the macro shifts. 

1. Let us talk about GDP growth projected for coming years. For the current year CY2023, the real GDP is expected to grow by 2.1%. This is likely to be largely helped by lower retail inflation. However, the real GDP growth is likely to taper to 1.50% in 2024, but bounce  back to 1.80% for 2025 and 2026, which will be long term equilibrium rate. Compared to June, September projections of GDP growth are 110 bps higher for 2023 while the projections for 2024 are 40 bps higher.

    

2. How about the unemployment projections for coming years. For the CY2023, the unemployment rate is expected at 3.8%, compared to the June projection at 4.1%. This is likely to be largely helped by demand for jobs still exceeding the supply. Similarly, the unemployment rate projections for CY2024 have been lowered by 40 bps to 4.1% and the same has been the case for CY2025 also. Long term projections were held intact. 

    

3. Let us turn to the PCE inflation and the core PCE inflation projections for the coming years. For CY2023, the PCE inflation at 3.3% is higher than the June projection of 3.2%. At the same time, the projection of core PCE inflation has been lowered by 20 bps in the September projection to 3.7%. This is an indication that while structural inflation is likely to come down, the fuel and food inflation could still be a cyclical problem for the US economy. Longer term projections for PCE headline inflation and for PCE core inflation are marginally higher compared to the June 2023 projections. Clearly, the FOMC was pencilling a higher risk of projection in September. 

    

4. What does all this data overload mean for the rate projections for the coming years as per the September 2023 data. Clearly, the Fed belief in September was that inflation may not spike but it may remain persistent for much longer. Hence the Fed had mentally prepared itself for a policy of holding rates at higher levels for a longer period of time. That is evident from the enhanced rate projections for future years. For example, Fed rates at the end of 2024 were projected at 4.6% but in September that number has been further raised to 5.1%. Similarly, the projections of Fed rates at the end of 2025 were originally pegged at 3.4%, but that has now been upped to 3.9%.

To sum up, the outlook had been a lot more cautious and hawkish in September. The question is how have these projections of various macros changed in December and whether they have changed at all? 

Present Day – How December FOMC projections changed over September 2023

Previously, we spoke about estimates made by the Federal Open Markets Committee (FOMC) at the time of September Fed statement and we now have the updated version of the estimates as of December 2023. The comparison lets us understand how the FOMC projections of various macros for the US economy have changed over the last 3 months and what it says about the thinking of the US Fed on the future of inflation, growth, and rates?

Variable	CY-2023	CY-2024	CY-2025	CY-2026	Longer run
Change in real GDP (Dec-23)	2.60	1.40	1.80	1.90	1.80
September projection	2.10	1.50	1.80	1.80	1.80
Unemployment rate (Dec-23)	3.80	4.10	4.10	4.10	4.10
September projection	3.80	4.10	4.10	4.00	4.00
PCE inflation (Dec-23)	2.80	2.40	2.10	2.00	2.00
September projection	3.30	2.50	2.20	2.00	2.00
Core PCE inflation (Dec-23)	3.20	2.40	2.20	2.00
September projection	3.70	2.60	2.30	2.00
Federal funds rate (Dec-23)	5.40	4.60	3.60	2.90	2.50
September projection	5.60	5.10	3.90	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.

1. Let us first talk about the GDP growth projected for the coming years. For the current year CY2023, the real GDP is expected to grow by 2.6%. This is likely to be largely helped by lower retail inflation. However, the real GDP growth is likely to fall to 1.40% in 2024, but bounce  back to 1.80% for 2025 and 1.90% in 2026, The long term GDP growth rate is likely to settle in at around the 1.8% mark, and this will be the sustainable rate.

    

2. Let us quickly turn to how the GDP growth projection compares with the projections last made in September 2023. There is a clearly buoyancy visible. For example, for 2023, the June GDP growth projection was just 1%, which has been upped to 2.1% in September 2023 and has now been upped further to 2.6% in December 2023. However, the changes to future projections of GDP beyond 2023 are not too significant with just about 10 bps variation. This is a clear indication that the fears of hard landing may be misplaced and the Fed may have actually managed a soft landing while reining in inflation.

    

3. Let us turn to the unemployment projections for the coming years. For the current year CY2023, the unemployment rate is expected at 3.8%. 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 likely to increase to 4.1% in 2024, but taper back to 4.0% for 2025 and 2026. This should be seen as a comfortable level. If you compare the latest December projections with the September projections, there is not much of a change on the jobs front. The only difference is that the unemployment level projection for 2026 and beyond has been slightly upped by 10 basis points.

    

4. Let us turn to the PCE inflation and the core PCE inflation projections for the coming years. For the current year CY2023, the PCE inflation has been lowered to 2.8% from 3.3% projection in September. At the same time the PCE inflation projection has also been lowered by 50 bps from 3.7% in the September projection to 3.2% in the December 2023 projection. Future projections beyond 2023 have only changed marginally, but the message is that the Fed may have overestimated inflation in the current year and that is good news.

    

5. What do all these macros mean for the Fed rate projections for the next few years? The message is that the Fed rates as projected in December will be much lower than it was in September. For instance, the rate projection at the end of 2023 has been lowered by 20 bps from 5.6% to 5.4%. At the same time, the projection for 2024 has been lowered by 50 bps to 4.6% while the Fed rate projection for year 2025 has also been lowered by 30 basis points from 3.9% to 3.6%. The message that comes out is that while the longer term rate targets may still remain the same, the fall will be front-ended, instead of being back-ended as it appeared in the September projections.

The outcome of the projections was visible in the Fed guidance, wherein it guided for 3 rate cuts in 2024 and another 4 rate cuts in 2025. The CME Fedwatch is expecting full 7 rate cuts to happen in 2024, but that may be veering too much towards an impractical scenario. 

How will RBI interpret the FOMC macro projections?

There are clear positive takeaways from the macro projections in December. Firstly, the December projections underline that inflation is coming down quickly and also with a greater sense of purpose and determination. Secondly, the RBI has less to worry on the rates front and the comparative yields since even the US rates would be coming down in tandem. The RBI can, now, serious look at a timetable to change monetary tack and shift to cutting repo rates. Above all, it is the higher GDP projections what will warm the cockles for the RBI. It means that robust growth will result in better export demand and higher technology spending by US corporates. That is worth a lot for India.