·       4^th Quarter GDP exceeded expectations, while inflation moderated

·       “Goldilocks” scenario and easing inflation should be supportive of financial markets

The US Economy is going strong

US GDP expanded in the fourth quarter of 2023 at 3.3%, much higher than the expected 2.0%[1], as the largest economy continues to show signs of strength.

Source: FRED

The U.S. reported a robust 3.3% annualized growth in GDP for the fourth quarter, significantly surpassing the anticipated 2.0% expansion. This impressive performance was largely due to the continued strength in consumer spending, which increased by 2.8%. This marks the sixth consecutive quarter where the U.S. economy has grown by over 2.0%, exceeding the expected potential growth rate of 1.5% to 2.0%, even amidst elevated interest rates. The past two quarters have been solid, with 4.9% and 3.3% growth rates, respectively, indicating a trend well above the average.

Looking ahead, a slight decrease in growth is anticipated, potentially aligning with, or falling slightly below the usual growth trend. This expected slowdown could stem from decreased consumer spending and a potential overdue easing in the labour market. However, it’s unlikely that this will lead to a negative growth scenario.

The prospect of a ‘soft landing’ for the number one economy in the world still seems plausible. As the year unfolds, there’s potential for a renewed increase in economic growth, especially if inflation continues to ease, allowing the Federal Reserve to lower interest rates and ultimately benefit the consumer.

Inflation data in line with Goldilocks scenario

The most recent data on the personal consumption expenditure (PCE) deflator, a preferred inflation gauge of the Federal Reserve, indicates a clear downward trend. The core index, which excludes volatile components like food and energy, has slightly fallen below 3%[2] and is way down from a high of 5.6% in 2022.

Source: FRED

Notably, the year-over-year core PCE inflation now stands at 2.9%, a decrease from the previous month’s 3.2% and under 3.0% for the first time since 2021. This consistent decrease in inflation, despite the economy growing above its usual trend, fuels optimism about the Federal Reserve’s potential to commence reducing policy rates as the year progresses, aiming for more neutral rates.

This occurred alongside a strong job market that continued to fuel consumer spending. Although some of this momentum is predicted to slow down in the current year, numerous analysts still anticipate that the economy will avoid a recession.

Markets do well in a “Soft Landing.”

Traditionally, market performance often improves when the Federal Reserve initiates a cycle of reducing interest rates and the economy is not experiencing a recession.

Source: Edward Jones

Looking back to 1990, the average 12-month return following the initial rate cut by the Fed during non-recession periods is approximately 7.6%[3]. This contrasts with a mere 0.5% return during recessionary periods. The recent robust economic data from the U.S. suggests a growing possibility of a soft-landing scenario in 2024, potentially leading to favourable market returns as the Fed starts lowering rates.

The S&P 500 saw a 24% increase last year[4]. This significant growth was partly due to excitement surrounding artificial intelligence (AI) and reflected the US economy’s resilience despite the Fed’s persistent rate increase.

However, last year’s gains were concentrated in a narrow group of stocks known as the “Magnificent 7”.

Historical trends suggest that markets have the potential to prosper in a scenario where inflation eases and the Fed cuts rates, particularly when the economy manages a smooth landing.

Combining a robust economy and diminishing inflation enhances the likelihood of a smooth economic adjustment.

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