Goldman Sachs' Ten Questions for the US Economy in 2024: How will the economic growth be? How many times will the Federal Reserve cut interest rates? Has inflation really cooled down?

Even before 2024 has begun, the sudden shift in the Federal Reserve's stance has forced Wall Street investment banks to rewrite their 2024 outlooks.

In the latest release of "10 Questions for the U.S. Economy in 2024" by Goldman Sachs' Chief Economist Jan Hatzius, there are significant differences compared to the November release of "Goldman Sachs 2024 Macro Outlook" in terms of the U.S. economy, bank credit growth, and the Fed's rate cut expectations.

Overall, Goldman Sachs believes that the Federal Reserve will significantly cut interest rates in 2024, at least four times. In November, Goldman Sachs predicted that the Fed would only cut rates once in 2024, and it would be in the fourth quarter.

Under the impact of substantial rate cuts, Goldman Sachs believes that credit growth in the U.S. banking industry will accelerate again. In November, Goldman Sachs stated that with interest rates expected to remain at higher levels in the long term, it may expose the "vulnerable areas" of the U.S. banking industry, with continued pressure on credit for small banks.

At the same time, Goldman Sachs believes that the U.S. economy will avoid a recession due to the Fed's early rate cuts. They predict that the GDP growth rate for the fourth quarter of 2024 will be 2%. In the November report, Goldman Sachs emphasized that there is a 15% possibility of an economic recession in the U.S. in 2024.

1. Will the Federal Reserve cut rates at least four times?

Goldman Sachs' answer: Yes.

Goldman Sachs points out that due to unexpected cooling of inflation, certain indicators show that inflation levels are already close to 2%. They expect the Federal Reserve to cut rates early and rapidly. In 2024, the Fed will cut rates five times, and in 2025, they will cut rates three more times:

We expect the Fed to cut rates by 25 basis points in March, May, and June consecutively, and then cut rates once per quarter (or every two meetings) until the federal funds rate reaches 3.25-3.5% by 2025.

Goldman Sachs openly states that they are predicting what the Federal Reserve might do, rather than what they "should" do. Based on the Fed's view of the economy, their rate cut projections are more urgent compared to previous analyses:

Our financial conditions index growth model suggests that the impact of higher rates has already passed, so rate cuts next year don't need to be too rushed. However, Powell stated in December that the FOMC is "very concerned" about the risk of maintaining high rates for a long time. We also doubt whether the neutral rate is as low as the Fed believes.

2. Will core PCE in Q4 2024 be lower than the Fed's forecast of 2.4%?

Goldman Sachs' response: Yes.

Goldman Sachs believes that US inflation will continue to decline and that the Federal Reserve's "last mile" will not be as difficult as imagined. It is expected that the core PCE will decrease from 3.2% to 2.2% by Q4 2024:

The latest data shows that the year-on-year growth of core PCE in the US in November was 3.2%, the lowest since April 2021 and lower than market expectations. It seems that the slowdown in inflation is becoming a global trend, which gives us more confidence - the rapid decline in US inflation is not a temporary trend.

We are confident that the year-on-year growth rate of core PCE will continue to decrease significantly from the current 3.2% next year, as labor, car prices, and the rental market prices are all declining.

With the end of the major strike in the automotive industry, automobile inventory levels are expected to rebound quickly, and the "price war" among car companies may become more intense. We expect core PCE to drop to 2.2%, with core goods inflation decreasing by 1.1% to -1% and core services inflation decreasing by 0.9% to 3.4%.

3. Will the Federal Reserve stop quantitative tightening (QT) in the third quarter of next year?

Goldman Sachs' response: No.

Goldman Sachs believes that the FOMC will stop quantitative tightening when bank reserves change from "abundant" to "sufficient". It is expected that the adjustment of the pace of quantitative tightening will be considered in the third quarter of 2024, gradually slowing down in the fourth quarter of 2024, and stopping in the first quarter of 2025:

When bank reserves change from "abundant" to "sufficient", it also means that the change in reserve supply will have a moderate impact on short-term interest rates, and the FOMC may stop quantitative tightening. According to model calculations, short-term interest rates will become more sensitive to changes in reserves around the third quarter of 2024, and it is expected that the Federal Reserve will begin to slow down the pace of quantitative tightening at that time.

In the fourth quarter of 2024, it is expected that the Federal Reserve will halve the monthly reduction limit of Treasury bonds from $60 billion to $30 billion, and halve the monthly reduction limit of MBS securities (mortgage-backed securities) to $17.5 billion.

We expect the Federal Reserve to stop quantitative tightening in the first quarter of 2025. At that time, bank reserves will account for 12-13% of bank assets (currently 14%), which is about $2.9 trillion (currently $3.3 trillion), and the Federal Reserve's balance sheet will account for about 22% of GDP (currently about 30%, about 18% in 2019).

The current key risk is that the increase in US debt supply in 2024 may cause significant volatility in the US Treasury market, which may lead to monetary market fluctuations or an early termination of quantitative tightening by the Federal Reserve.

4. Will credit growth in the US banking industry accelerate again?

Goldman Sachs' answer: Yes.

Goldman Sachs points out that the growth of bank loans in the US banking industry has slowed from 8% last year to 2% this year due to the continued tightening of credit standards in the industry. However, the banking industry storm has subsided, commercial real estate risks are under control, and with the optimistic economic outlook for 2024, bank loans will accelerate again:

Some analysts are concerned that banks may face difficulties due to loan losses in commercial real estate (CRE), leading to a credit crunch next year.

We are not too worried about this, and we expect bank loans to have a trend of accelerating again next year. Our banking and credit analysts emphasize that most of the risks in CRE have been priced in the bond market, and the risks of office buildings should be manageable.

At the same time, the banking crisis in March this year has subsided, and the trend of large-scale deposit outflows has ended. Deposit beta values remain within the normal range, and net interest margins remain stable. With interest rates now declining, concerns about unrealized losses on banks' balance sheets, which initially caused panic, have further diminished.

Combined with the optimistic expectations for the economic outlook in 2024, this should lead to a reacceleration of bank loans.

Non-bank lending institutions have reduced new loans to businesses less than banks this year, mitigating the impact on overall credit availability. And as concerns about a recession recede, they should also be more willing to lend.

5. Will the US unemployment rate remain below 4% in 2024?

Goldman Sachs' answer: Yes.

Goldman Sachs points out that the unemployment rate experienced a brief increase in the fall of this year, but it has dropped to 3.7% in November, and other labor market data is very strong, so there is no need to worry about the short-term increase in the unemployment rate:

We are not concerned about the increase in the unemployment rate since the spring, as other labor market data remains very strong: job vacancies are high in almost every industry, and the number of layoffs and initial claims for unemployment benefits is very low.

Goldman Sachs believes that the current unemployment rate of 3.7% is a good starting point for 2024, coupled with strong final consumer demand and fading concerns about a recession, employment will continue to grow steadily in 2024, and the unemployment rate is expected to fluctuate slightly around 3.6%.

6. Will wage growth fall below 4%?

Goldman Sachs' answer: Yes.

Goldman Sachs points out that the two main factors driving wage growth in the past two years have been a tight labor market and the impact of inflation, but these two factors have now returned to normal levels, and wage growth is expected to decline:

Data shows that the labor gap in 2023 reached a peak of nearly 6 million, and short-term inflation expectations have impacted residents' living costs. But now the measure of labor market tightness has returned to pre-pandemic levels, and short-term inflation expectations have returned to the mean. Therefore, we expect the wage growth rate to gradually slow down. Tracking data shows that the wage growth rate has slowed down from a peak rate of 5.5-6% to 4-4.5%.

Goldman Sachs believes that the wage growth rate will drop to 3.5% next year, in line with the condition of inflation dropping to 2%:

Surveys show that companies' expectations for wage growth next year have also further slowed down. Wage growth is the only data that the Federal Reserve uses to measure inflation prospects that has not yet reached the desired level, and it is the only data that does not support the Federal Reserve's initiation of an interest rate cut cycle, but it is already very close.

Goldman Sachs believes that the high wage growth rate is due to its own lag:

This is particularly evident in recent wage negotiations with union members. Generally, the signing of contracts takes a long time, which has delayed the opportunity for some people to get a raise until this year.

1. Will the US GDP growth rate in 2024 exceed market consensus and the Federal Reserve's expectations?

Goldman Sachs' answer: Yes.

Goldman Sachs bluntly stated that their most out-of-consensus forecast for 2024 is that the GDP growth rate in the fourth quarter of 2024 will be 2%, far higher than the consensus expectation of 0.9% and the Federal Reserve's expectation of 1.4%.

Goldman Sachs believes that their economic forecast is not overly optimistic. The short-term potential growth rate of the US economy is currently about 2%. The unexpected growth of the immigrant population has driven the prosperity of the labor market and slightly boosted the short-term potential growth rate of the economy.

We expect that the explanation for the GDP growth rate next year being close to the potential growth rate is that the impact of changes in fiscal policy and financial conditions is likely to be roughly neutral.

This assessment is likely to be the key reason why we differ from the consensus-some investment banks still expect that high interest rates will have a more serious lagging impact on the economy in their research reports.

1. Will the US government further implement fiscal stimulus before the election?

Goldman Sachs' answer: No.

Goldman Sachs believes that although fiscal policy usually tends to be expansionary in election years, next year's fiscal spending will still be constrained by the debt ceiling agreement, and fiscal expansion in 2024 may face greater constraints:

Next year's fiscal spending will still be constrained by the debt ceiling agreement, which is a situation that occurs less frequently in previous election years. During the debt ceiling negotiations in 2023, the bipartisan "Fiscal Responsibility Act" set the autonomous spending limit for 2024 at $15.9 trillion (including defense spending of $886 billion and non-defense spending of $704 billion), and for 2025 at $16.1 trillion (including defense spending of $895 billion and non-defense spending of $711 billion).

If the formal appropriation bill is not passed before January 1, 2024, the spending limit for the 2024 fiscal year will be reduced by 1% based on the previous year, and within this lower total, $33 billion will be transferred from the defense department to the non-defense department. Due to this reduction, which will be implemented in May 2024, it will be concentrated in the second half of the fiscal year, resulting in a decrease in funds of about 2% (0.4% of GDP).

9. Will consumer spending exceed expectations?

Goldman Sachs' answer: Yes.

Goldman Sachs believes that consumer spending in 2024 will exceed expectations. Although not as strong as this year, it will still be positive. It is expected that consumer spending growth next year will reach 3%, mainly driven by the growth of residents' income:

Labor force growth and productivity improvement often increase the potential economic growth level, which in turn translates into higher consumer spending.

Currently, the number of job vacancies is still high, which means that corporate recruitment is still strong, leading to a virtuous cycle of expected income growth and consumption growth.

Goldman Sachs predicts that residents' interest income may also increase significantly next year:

With the increase in interest income, we expect the savings rate to rise by about 1 percentage point, which means that about 2% of income growth should be converted into about 2% of consumption growth, far exceeding the consensus expectation of 1% growth.

Some believe that the low savings rate of US residents and the depletion of excess savings will be detrimental to consumer spending. Goldman Sachs believes that these two points do not need to be overly worried:

1. In terms of the savings rate, the current savings rate of 4.1% is below the average level, due to weak precautionary savings and retirement savings.

The unemployment rate is low, and the ratio of household net assets to income is at a historical high. In this context, there is no need to worry about the low savings rate, and according to our forecast, the savings rate will also increase moderately next year.

1. Concerns about the depletion of excess savings in the market have also been exaggerated.

Excess savings during the pandemic provided support for consumption in 2022, but it is worth noting that this was caused by two unusual conditions: first, a decrease in real income, which means that many households needed to use savings to maintain their actual expenses; second, households with low savings had some funds.

By 2023, real income has risen, and by the end of 2022, the liquid financial assets of low-income households have returned to normal levels. At this time, excess savings are only a small increment for middle and high-income consumers, accounting for about 1% of net assets, so they should not receive too much attention.

10. Will the difference between physical consumption and service consumption return to the pre-pandemic trend?

Goldman Sachs' answer: No.

Goldman Sachs believes that the habit of working from home will continue to drive the gap between physical consumption and service consumption:

Remote work seems to have become a long-lasting habit after the pandemic. The proportion of employees who work from home for part of the week in the United States has stabilized at about 20-25%, lower than the peak of 47% during the pandemic, but much higher than the average level of 2-3% before the pandemic. This habit of working from home may be the main driving force behind the significant gap between physical consumption and service consumption. According to credit card data on urban consumption, remote workers spend less on services near the office, such as transportation, and more on home offices and entertainment products. This indicates that many changes in consumption patterns are likely to be long-lasting.