submitted by
Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
Will the economy cause the Fed to slow rate cuts? The probability of another Fed rate cut in December has come down from upwards of 80% to about 66%. As we move into 2025, the pace of cuts is expected to slow, counter to expectations at the advent of the rate-cutting cycle. There are two primary reasons for the expected slowing of cuts: a strong economy and the stickiness of inflation.
The Fed led the cutting cycle with an unexpected reduction of 50 basis points. This was in the middle of an existing strong economy and inflation, while lower than the start of the year, had still not reached the target of 2%. The Fed will reduce in December, but expect January odds to come down after the release of economic data, shifting the odds to no reduction in January.
For the strength of the economy, we can look at gross domestic product (GDP), which is the market value of goods and services produced by the macroeconomy. The latest figures show that GDP increased by 2.8%, from the 2nd to the 3rd quarter of 2024. This is well above the average quarterly growth since 2022. And the consumer is driving this growth, responsible for a whopping 85% of the 2.8%.
While consumer sentiment remains depressed, largely due to the negative effects of inflation, consumers remain confident due to a couple of ongoing dynamics. One is the labor market. While the labor market has softened, the unemployment rate remains at relatively low levels and job openings continue to exceed the number of unemployed. Layoffs, as measured by new claims for unemployment, are at historically low levels. Current levels are just over 200,000 weekly, and these are nowhere near levels needed for any hints of a recession. The other factor driving consumer spending is household balance sheets. The net worth of households is at an all-time high, driven by home values and the equity markets. During the Great Recession, it took about 5 years to recover the net worth lost during the housing crash and equity market losses. Coming out of Covid, household wealth suffered declines in 2022 but has been climbing since. Strong balance sheets encourage spending, and this is showing up in sustained consumer spending, the big driver of gross domestic product.
Since the Fed began its rate-cutting cycle, inflation is higher than it was at the end of September. The post-Fed cut inflation rate was 2.41% at the end of September and the most recent data places headline CPI at 2.6%. The core rate, CPI minus food and energy, is even higher at 3.3%. We see the impact of this sticky inflation on the 10-year yield, higher now than levels that existed just prior to the September Fed rate reduction. For the consumer, this means elevated mortgage rates compared to the recent low of 6.1%.
In summary, the Fed will likely cut in December. The absence of a cut would signal the mistake that was made in September, but unless the data deteriorates considerably, expect a pause for January.
Regional Updates
As 2024 comes to an end, the Louisville Metro area will see slower payrolls this year compared to 2023. Latest preliminary estimates show that Louisville payrolls are up about 3,700 from the prior year, and the unemployment rate about 3/4% higher than 2023, 4.2% compared to 3.5% last year. The region saw gains in education and health services, transportation and warehousing, and professional and business services. However, losses in leisure and hospitality, manufacturing, financial activities, retail and information provided headwinds to overall payroll growth.
We see similar patterns in Southern Indiana. The most recent county data show that Southern Indiana gained over 1,000 jobs in the second quarter of 2023, compared to the prior year. Healthcare and transportation and warehousing were the dominant growth sectors and manufacturing saw another decline, over 1,000 payrolls.
These most recent changes for Southern Indiana are consistent with the pattern that emerges from pre-Covid to now. Since 2019, the year prior to Covid, the largest gainer for Southern Indiana is transportation and warehousing, followed by health care and social services. Accommodation and food services is up just over 1,000 positions. The greatest loss is observed for manufacturing, down more than 2,500 jobs since 2019. Even with this significant decline, both total wages and average weekly wages are higher, pointing to productivity gains in regional manufacturing. Despite the decline in payrolls, manufacturing also remains as the sector with the highest level of total wages across Southern Indiana, reinforcing the role as an impactful economic development sector.
As we exit 2024, the region can expect an acceleration of payroll growth and an unemployment rate that remains relatively flat. Expect volatility in the markets, but the U.S. will avoid a recession.
As the macroeconomy accelerates in growth, the battle between growth and inflation will ensue. Supporting both growth and disinflation will be a supply side boost to the economy, brought about by a deregulatory environment, and incentives that boost labor force participation and capital investment.
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