Augustine (Gus) Faucher is senior vice president and chief economist of The PNC Financial Services Group, serving as the principal spokesperson on all economic issues for PNC.
Prior to joining PNC as senior macroeconomist in December 2011, Faucher worked for 10 years at Moody’s Analytics (formerly Economy.com), where he was a director and senior economist. He was responsible for running the firm’s computer model of the U.S. economy, edited a monthly publication on the U.S. economic outlook, covered fiscal and monetary policy, and analyzed various regional economies. Previously, he worked for six years at the U.S. Treasury Department, and taught at the University of Illinois at Urbana-Champaign. He was named senior vice president in March 2015, deputy chief economist in February 2016, and to his current role in April 2017.
Faucher is frequently cited in international, national, and regional media outlets including The Wall Street Journal and The New York Times. He has appeared on ABC World News, CBS Evening News, NBC Nightly News and Nightly Business Report, and is regularly featured on CNBC, CNN and Fox Business. In addition, he appears regularly on CBS Radio, NPR and Marketplace.
Hello, this is Gus Faucher, Chief Economist for the PNC Financial Services Group, with an Economic Outlook for the first quarter of 2024. The Federal Reserve has dramatically increased both short and long term interest rates over the past few years in an effort to combat high inflation. The Fed has raised the Fed funds rate, their key short term interest rate, from close to zero at the beginning of 2022, to a range of between 5.25 and 5.5 percent by early 2024. Similarly, long term interest rates have gone up as the Fed has reduced the size of its balance sheet and its, and in particular, its holding of long term securities like long term treasuries and mortgage backed securities. But the U. S. Economy remains very, very strong in early 2024.
In particular, the labor market is incredibly strong. The unemployment rate remains near a 50 year low and job growth remains solid. The U. S. Economy, after losing 22 million jobs in March and April of 2020 with the pandemic, has added back all of those jobs and more, almost 5 million new jobs compared to before the pandemic.
And job growth is back on its pre pandemic trend. Similarly, overall economic output adjusted for inflation continues to grow. This chart shows three measures of economic activity. The peak before the pandemic is set equal to 100. And you can see that after a steep contraction in the economy in early 2020 with the pandemic, basically, the economy was about 8 percent smaller in the second quarter of 2020 compared to the fourth quarter of 2019.
The economy has recovered strongly and the economy is now back on trend and is somewhere between 5 and 7 percent larger than it was before the pandemic. That being said, inflation remains a significant concern for the Federal Reserve and in particular core services inflation, the blue line, remains stubbornly high.
Much of this inflation is wage driven, that is, it's caused by higher wages in service industries. And strong wage growth with the tight labor market has pushed up core services inflation. It has slowed somewhat over the last year, but remains elevated, and overall inflation is still above the Federal Reserve's 2 percent objective.
There is good news on the inflation front, however. Energy prices are down over the past year, food and beverage inflation has slowed significantly, and inflation for core goods, that is goods excluding food and energy, is basically zero. But the Fed wants to see a bit softer wage growth, a bit more slack in the labor market, and that should help bring down core services inflation and overall inflation.
With inflation elevated, the Federal Reserve has been pushing up interest rates. So, for example, the typical interest rate on a 30 year fixed rate mortgage has gone from below 3 percent as recently as late 2021 to around 7. 5 percent currently. Not surprisingly, this is weighing on the housing market.
Sales of existing single family homes have declined from around 6 million per year to around 3. 5 million per year with higher rates. And this is how the Federal Reserve works. By raising interest rates, they make it more expensive for borrowers. That, in turn, reduces activities like home buying, consumer purchases of big ticket items like cars and appliances, and business investment.
PNC's baseline outlook is for a mild recession starting in the middle of 2024 as the cumulative impact of higher interest rates continues to weigh on the economy. But the recession should be short and mild. In particular, consumers have accumulated a lot of savings over the past few years thanks to reduced opportunities to spend with the pandemic and government aid, particularly higher stimulus payments, extra unemployment insurance benefits, and assistance to small businesses through the Paycheck Protection Program. Similarly, consumer debt burdens relative to incomes are low. The orange line is the financial obligations ratio, the share of after tax income that goes to consumer debt payments like mortgages and rents, homeowners insurance, auto loans and leases, and similar payments.
That is extremely low right now, lower than it was before the pandemic, and much lower than it was heading into the housing crisis in 2007. And so that means that consumers do have room to increase their borrowing, even if there is a slowdown in the economy. Similarly, the labor market remains extremely tight.
The labor force participation rate, the share of adults who are working or looking for work, is below where it was before the pandemic. That will force businesses to avoid layoffs, and that will limit the hit to consumer incomes and to consumer spending. The most likely outcome is a mild recession starting in mid 2024, as higher interest rates continue to weigh on the U.S. economy. However, it should be a mild and short downturn because of reduced layoffs relative to other recessions and strong consumer balance sheets. Real GDP will decline by about one half of a percent to one percent, and the unemployment rate, which is near a 50 year low, will increase only modestly to around five percent, peaking in early 2025.
Economy should start to turn around by late 2024 or early 2025 as the Federal reserve cuts interest rates in response to slowing inflation and a softening economy. Thank you very much for your time.
You can find all of our materials at pnc.com/economicreports, and you can follow me on X, formerly Twitter, at @GusFaucherPNC.