• While the US economy continues to surprise, we expect the Fed to remain cautious.
• Faced with persistent inflation above its 2% target, we believe that the Fed will move cautiously towards its first rate cut.
• At Vanguard, we have upgraded our US economic forecasts based on stronger growth and a sturdy labour market.

The Goldilocks outcome of strong growth and lower inflation in the US was achieved by a timely expansion in the supply side of the economy - mainly better-than-expected gains in the workforce and productivity. This explains our updated economic forecasts anticipating stronger growth, a sturdy labour market, stubborn inflation and a central bank that will move cautiously towards its first interest rate cut. We also consider the possibility of the Fed not being able to cut interest rates at all this year.

Given that interest rates last year were aimed at subduing inflation by restricting economic activity, we would not have expected GDP growth as robust as 3% in 2023. Stronger-than-expected labour supply and productivity gains more than offset the US Federal Reserve’s (Fed) aggressive monetary policy tightening. These favourable supply-side forces (the production of goods and services to drive economic growth) are likely to subside only gradually, boosting our outlook for 2024. We foresee economic growth of around 2% for 2024 and a year-end unemployment rate of around 4%.

Meanwhile, we expect demand to persist. As the economy remains resilient and with strong underlying demand, we continue to see the “last mile” of the inflation fight as the most difficult. We believe that the core Personal Consumption Expenditures price index, the Fed’s preferred measure of inflation, won’t follow a smooth path toward the Fed’s 2% goal, with the risk of staying above 2.5% for the year, higher than previously anticipated (core inflation excludes volatile food and energy prices).

The Fed will likely remain cautious

Faced with persistent inflation above its 2% target and the risk of financial conditions easing too rapidly, we believe that the Fed will move cautiously towards its first interest rate cut. Moreover, it’s entirely possible that the Fed may not be in a position to cut interest rates this year and will maintain its federal funds rate target around its current range of 5.25%–5.5% for the rest of 2024.

But a “soft-landing” scenario with moderate Fed interest rate cuts can’t be ruled out. If strong supply-side forces were to persist in 2024, that would likely create conditions in which inflation returned to the Fed’s target at a faster pace without weakening economic growth or the labour market.

In that case, supply-side tailwinds would help the Fed achieve the coveted soft landing. Because Fed policy doesn’t control the supply side of the economy, such a soft landing would be a welcome and lucky outcome. At the other end of the spectrum, a late-year recession—while no longer our base case—is still possible. We believe it could occur now only if favourable supply-side forces were to subside more quickly than anticipated.

A return to sound money still applies

The developments continue to underscore our view that we have entered an era of “sound money” with interest rates above the rate of inflation. Having a balanced and diversified investment portfolio is always important. Sound money provides a solid foundation for long-term risk-adjusted returns.

Investment risk information

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