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Economic Update

Economic Update January 2025
The US economy is in an economic expansion. It is in decent shape with uncomfortable inflation pressure, still an issue for the Federal Reserve. A series of inflation measures have stalled out but is expected to moderate by year-end. The Fed said its pace of cuts would be more gradual in coming quarters. For now markets are discounting two more cuts and a pause in monetary easing policy. The economy is not rolling into a recession, in the worst case a slight slowdown. Deeper cuts in rates may alarm markets by signaling the economy needs a bailout or reignite inflation. The US economy is healthy! The Atlanta Fed GDPNow model estimate for real GDP growth in the fourth quarter of 2024 is 3.0%!
Here is a summary of the US economic forecast for 2025 provided by the Federal Reserve (Fed) and the Congressional Budget Office (CBO). These projections are based on current economic conditions as of December 2024.
GDP Growth: CBO expects to be around 2.3%. Consumer Spending. Almost 70% of GDP, is projected to moderate due to higher tax rates. This one is most likely to turn out wrong. The Trump administration is extending current tax rates. Furthermore, Households are in very sound financial condition. For example, the FRED Household Debt Service Payments as a Percent of Disposable Personal Income are low relative to history.
Inflation as measured by the CPI (Consumer Price Index) is projected to decline to 2.2% - I am not so sure this will happen. Inflation of 2.5-3% may be normal and acceptable if the US economy is expanding. Inflation expectations based on tariff rhetoric could be overstated and turn out to be inconsequential.
The PCE (Personal Consumption Expenditures), another way to measure inflation, and used by the Federal Reserve (Fed), is expected to fall to 2.5%. The Fed may be slightly off on this one. The Trump administration economic policies are stimulative to economic growth and inflationary in some respects. Lower energy prices should help offset any aspects of Trump policy that is inflationary. Moreover, the adaptation of AI is an anti-inflationary force that increases productivity gains. Tariffs are in part being used as a bargaining chip and may never be used widespread. Trump is reviewing Tariffs that are scaled and phased in. Presently, a tariff of 10% on China imports is being considered in response to US Government’s endless request for China to stop sending fentanyl to Mexico and Canada to kill our children. The AI capex boosting investment spending has usually led to productivity gains in time, over many years, which offset inflation according to Fidelity. Labor market productivity remained in a cyclical upswing.
The Federal Reserve’s preferred inflation gauge, the PCE Core (Core Personal Consumption Expenditures), a price index that measures the cost of goods and services, excluding food and energy, in the U.S. economy, rose by 12-month inflation rate at 2.8%. The Fed forecasts it to decrease to 2.2%. This one is off the mark. The Fed would have to see a scary slowdown in the economy for this to come to fruition. Unemployment would be higher than its forecast.
Historically, there have been several episodes in the postwar era in which inflation exceeded 5%, decelerated, and then exhibited a second wave over the next two years. Absent a more significant economic slowdown, persistent core inflationary pressures still pose a risk to the outlook research note from Fidelity Investments. Headline inflation, measured by the CPI Index, is 2.9%. Inflation of 3% is normal and healthy. For reference point, from 1960 to 2022, the average inflation rate was 3.8% per year according to the Federal Reserve.
Real Wage Growth: CBO expects it to slow down as economic growth and inflation ease. It remains on its current track of 5%. Unemployment is expected to remain low. The Fed is projecting the Unemployment Rate to slightly to 4.3%.
So far, rising interest rates have not hurt the overall economy, with housing the exception, when looking at unemployment levels. The Labor Department’s most recent reports show job creation beating consensus forecast, and the unemployment rate dropping to 4.1%. Historically, the figure is full employment. The FOMC projects unemployment to reach 4.3% in 2025. A healthy jobs market means consumer spending stays robust, and the Fed may not cut the Federal Funds Rate as much as the bond market has already discounted.
What is the biggest threat to the US economy? Debt and deficit spending. The federal budget deficit rose 40% higher than it was the prior year. The fiscal deficit is now 6.5% of GDP compared to 3.1% in 2017 based on reporting from Congressional Budget Office. Interest payments are set to grab an even larger share of budgets in the coming years, keeping deficits large and pushing U.S. debt levels to all-time highs. The US Government has ignored deficit and debt levels by continuing to spend and issue more debt to pay for spending. The bond markets are the ultimate watch dog of deteriorating fiscal situation and will limit normal purchases of US Treasuries, driving down prices and up yields. If the Government will not cut spending, then the US economy must pull out all the stops to grow its way out of debt.
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