Why the bounce? We think it has much to do with disinflation. Yes, inflation remains well above the normal levels that have prevailed over the long term. But headline inflation, which includes energy costs, has slowed from a growth rate of more than 6% at the beginning of the year to roughly 3% today. That has helped household income go further and boosted overall confidence.
Will this continue? Yes and no.
Let’s start with the affirmative. We expect to see some additional disinflation and anticipate that the Fed will hit its 2% inflation target sometime in 2024. But keep in mind that inflation has fallen by more than 3% over the past six months. An additional 1% slide over the next 18 months is unlikely to provide the same sort of boost in consumer confidence.
Then there’s the labor market. We expect to see some slowdown there, too. Wage growth has already fallen by about 1.5 percentage points this year—about half the amount by which inflation has slowed—and we think there may be further decline. As inflation comes down, firms will feel less pressure to raise wages.
In addition to slowing wage growth, we have started to see broader signs of labor market cooling. The number of open jobs has started to decline, and the rate of hiring has fallen over the course of the year.
To be clear, the labor market is still strong. While there are signs that it is easing somewhat, there is still a long way to go. So even though we expect the process to continue, we don’t expect consumer sentiment to plumb the depths to which corporate sentiment has fallen.
Instead, we expect the two readings to meet somewhere in the middle. Businesses will be buoyed by consumer spending in the coming months, which should boost their perception of the economy. And households will likely perceive a bit of weakening in their situation as the labor market cools. That combination suggests to us that rather than focusing too intently on one or the other, the best way to view the path forward is to split the difference: things aren’t as bad as businesses perceive them to be, nor are they as rosy as households seem to think.
When it comes to our forecast, this all adds up to GDP growth that will be positive, but below trend, for the next 18 months.