Fed estimates hint at the US economy normalizing by 2025

27 Mar 2023 , 09:26 AM

Typically, the 12 members of the FOMC arrive at a consensus estimates of various macro variables ranging from GDP growth to inflation to interest rates and also the unemployment data. The broad picture is that the normalization of the US economy would take longer than expected but the Fed does expect that the US economy should be back to normal conditions by year 2025.

Typically, in February 2023, the estimates are made available for the year 2023, 2024 and 2025. In addition, the projections are also made for the long run, which extends well beyond 2025. Remember that these projections assume that there are no further disruptions in the US economy and that it is able to get over challenges like a global slowdown and the US banking crisis by then. Typically, the FOMC takes estimates of the 12 members on a dot plot chart and arrives at a median estimate. Generally, the median estimates are more reliable as they are not impacted by outliers.

Big picture on the US macro projections

Let us first start with the big picture as is captured in the table below and then drill down to the specific areas of interest. These are the consensus projections of the 12 FOMC members for the next 3 years and also for the long run.

Macroeconomic Data	2023	2024	2025	Long Run
Change in real GDP	0.40	1.20	1.90	1.80
Unemployment rate	4.50	4.60	4.60	4.00
PCE inflation	3.30	2.50	2.10	2.00
Federal funds rate	5.10	4.30	3.10	2.50

Data Source: US Fed

As can be seen from the above table, there is still a lot of policy uncertainty that is likely to continue in the year 2023 and 2024. For instance, if one looks at the latest FOMC meeting minutes, Jerome Powell is quite explicit in his statement that there would be no rate cuts in the year 2023. However, if you go by the Fed Fund futures captured in the CME Fedwatch, the estimate is of 100 bps rate cut in 2023, followed by another 100 bps rate cut in 2024. 

If you look at the Fed Funds rate estimates (we have used median), then the FOMC members are pegging flat rates in 2023 and about 80-100 bps lower in 2024. The good news is that the Fed is keep long run Fed rates at 2.50%, which would be more realistic compared to the zero Fed rates maintained by the Fed since the financial crisis of 2008. The only ambitious projection appears to be on the unemployment front, which is projected at 4.5% for FY23, at a time when the current rate is 3.4%. This is the assumption underlying the rapid fall in inflation in the coming years, but we come back to that later.

Real GDP: Median looks good, not the range

For the last 5 years, the GDP growth was as under: 2018 (2.3%), 2019 (2.6%), 2020 (-1.6%), 2021 (5.7%) and 2022 (0.9%). The table below captures the projections of the FOMC members for the forthcoming years.

Projected Real GDP Growth (%)	2023	2024	2025	Longer run
Actual GDP Growth	N.A.	N.A.	N.A.	N.A.
Upper End of Range	1.30	2.00	2.20	2.50
Lower End of Range	-0.20	0.30	1.50	1.60
Median GDP growth	0.40	1.20	1.90	1.80

Data Source: US Fed

After a sharp 5.7% GDP bounce in 2021, on the back of a low 2020 COVID base, growth once again normalized to just about 0.9% in year 2022. However, the projections are a lot more interesting. GDP growth median is just about 0.40% for year 2023, but the median ranges from a 20 bps recession to a high of 1.3%. However, the GDP growth is likely to pick up to around 1.8%-1.9% in the year 2025 and stabilize at that level as the long term future growth rate in real GDP.

Unemployment: Is the Fed being too optimistic?

For the last 5 years, the Unemployment level was as under: 2018 (3.8%), 2019 (3.6%), 2020 (6.8%), 2021 (4.2%) and 2022 (3.6%). The table below captures the projections of the FOMC members for the forthcoming years.

Projected Unemployment Rate (%)	2023	2024	2025	Longer run
Actual Unemployment	N.A.	N.A.	N.A.	N.A.
Upper End of Range	4.80	5.20	4.90	4.70
Lower End of Range	3.90	4.00	3.80	3.50
Median Unemployment Rate	4.50	4.60	4.60	4.00

Data Source: US Fed

On the unemployment projections, the long run data appears to be quite in tune with the previous data points. However, it does sound quite ambitious that the Fed members expect the unemployment to surge from the current 3.4% to 4.5% by the end of year 2023. That would really imply a huge impact on growth and jobs and that is perhaps factored in the lower GDP projections for the current year. However, the projections look ambitious since recent data flows do not support such a sharp spike in unemployment.

PCE Inflation: It will boil down to oil

For the last 5 years, the PCE inflation, based on personal consumption expenditure was as under: 2018 (2.0%), 2019 (1.5%), 2020 (1.2%), 2021 (5.7%) and 2022 (5.7%). The Fed uses PCE inflation instead of consumer inflation as the decision point for interest rates. The table below captures the projections of the FOMC members for the forthcoming years.

Projected PCE Inflation (%)	2023	2024	2025	Longer run
Actual PCE Inflation	N.A.	N.A.	N.A.	N.A.
Upper End of Range	4.10	3.50	3.00	2.00
Lower End of Range	2.80	2.00	2.00	2.00
Median PCE Inflation	3.30	2.50	2.10	2.00

Data Source: US Fed

Once again, the projections on the PCE inflation are quite aggressive. For 2022, PCE inflation was at 5.7%, so expecting it to come down to a median of 3.3% in 2023 is quite ambitious, unless there is a palpable slowdown in the US economy. While consumption has slowed, a lot will depend on oil prices and if China recovery takes off during the year, most calculations of PCE inflation for the current year could go for a toss. 

Finally, what do these projections mean for Fed interest rates?

Since the rate hikes started in March 2023, the Fed has hiked rates by a full 475 basis points from the range of 0.00%-0.25% to the range of 4.75%-5.00%. Since November 2022, the Fed has reduced the intensity of rate hikes from 75 bps to 50 bps in December 2022. The two rate hikes in the year 2023 have been just 25 bps. What does that hold for the future?

Projected Fed Funds Rate (%)	2023	2024	2025	Longer run
Current Projected Fed Rate	5.10	4.30	3.10	2.50
Fed rate projected in Dec-22	5.10	4.10	3.10	2.50

Data Source: US Fed

There appears to be a gap between what the Fed members are projecting on rates and what the markets are projecting (as captured in the CME Fedwatch). The Fed is projecting no cuts in Fed rates in the year 2023, but a 100 bps cut  in Fed rates in the year 2024. However, the markets are betting on a 100 bps rate cut in 2023 supplemented by another 100-150 bps rate cut in 2024. Apparently, the markets are betting that the current banking crisis and its ramifications on growth would be much stronger that what the Fed is willing to admit at this point of time. That is something we will only know in the coming months.