Kicking off the new year, the Kenan Institute is highlighting five issue areas that we think will be top of mind for business leaders and policymakers in the 12 months ahead. Some of these topics entail significant uncertainty – how much the Fed will cut rates, how the election will impact business and consumer attitudes and activity – which challenges any effort at forecasting, yet which also creates opportunities for those who are prepared. To help you navigate the dynamic and often unpredictable economic landscape, we offer solutions-focused analysis of the year’s most salient issues.
It depends on your view of the economy. Many pundits have already declared victory on inflation, and markets are pricing in rate cuts for early this year. Are these forecasts justified?
We ran three separate scenarios using our balanced-approach model of Federal Reserve behavior, which, you can see by the solid blue line in the graph below, closely match actual Fed actions (solid red line). The blue dotted line past the present day incorporates the Fed governor and president’s median economic forecast from their latest Summary of Economic Projections. This soft-landing scenario anticipates the Fed will cut rates by 1¼ percentage points by the end of 2024, which is closer to what the markets expect than the Federal Open Market Committee’s median interest rate forecast, which predicts a three-quarters percentage point cut (illustrated by the black dotted line).
What are the economic assumptions behind these scenarios? If you believe that the economy and prices will continue to grow at last year’s pace of 3%, then the Fed should actually raise interest rates by 1¼ percentage points by the end of this year (green dotted line). Or if you expect that the economy will experience a mild recession and slowing of inflation, then the Fed should cut rates by 3 percentage points by the end of the year (orange dotted line). These are generalized scenarios, yet they represent realistic outcomes in 2024, and I would leave it to you to assign respective probabilities to each for an expected value calculation. The range of possible scenarios makes me wonder if businesses should be as certain about the soft landing or perfect outcome as the markets seem to reflect. Or should we all assume a bit more humility and trepidation as we step into the new year?
Whichever economic scenario is realized in the next year, it is unlikely to alleviate the country’s housing shortfall. The chart below shows that the gap between existing mortgage rates (orange line) and new mortgage rates (blue line) is unprecedentedly massive, persisting even after a recent drop in long-term interest rates that the markets have priced in due to the expected soft landing. High rates limit construction activity while making people less willing to move because most people have fixed-rate mortgages that are well below the current rates.
If there is a recession, interest rates would likely come down, but homebuyers, investors and builders don’t usually ramp up activity in the face of recessionary conditions. It is important to keep in mind the structural causes of much of the housing shortage, which include building stoppages during the housing bust following the 2007-09 global financial crisis, changes in migration patterns, and problematic zoning laws and other rules that limit high-density housing in many high-demand locations. In other words, there are crucial business and policy decisions that contribute more to the current housing shortage than does Federal Reserve policy.
How local communities deal with housing shortages is centrally important to their long-term growth prospects. By measuring and incorporating key indicators into our modeling – including housing activity – the American Growth Project details in near-real time the varied economic conditions experienced in microeconomies throughout the United States. We estimate that building permits, which are an important leading indicator of housing activity, declined nationally by 11.7% in 2023. As the map below illustrates, there is significant variance in outcomes from one area to the next. While many of our 150 largest Extended Metropolitan Areas (EMAs) saw declines in new housing permits – some exhibiting double-digit drops (illustrated in deep red in the map below) – one-quarter of our EMAs showed gains, which we expect will translate into an increase in housing activity in 2024.
We anticipate that even in the areas with positive housing activity, most of these gains will not be sufficient to offset softening consumer demand and slow job growth, which will drag overall economic activity in 2024. Our models forecast that almost all 150 EMAs will experience slowing growth in 2024, with 26 of our EMAs expected to exhibit declines in economic activity. In the ranking of expected growth in 2024, Austin remains in the top spot among our 50 largest microeconomies, with healthy local growth dynamics offsetting weak housing activity. Meanwhile, Oklahoma City is a notable climber, moving up five slots from last year and into the top 10, bolstered by the strength of its labor market. For more information on our local economic forecasts, see “Microeconomies in 2024.”
Businesses and households tend to try to minimize uncertainty – why make long-term investments when the earnings path, interest rates or regulatory policies are unknown? Unfortunately, geopolitical uncertainty is likely to worsen in 2024 as the U.S. election season shifts into high gear and foreign wars continue to rage. A divided electorate representing stark differences in policy could mean wild swings in public sentiment. These swings would likely weigh on business investment and hiring as well as housing activity and consumer spending on durable goods such as cars and washing machines. The consequences would not only spell weaker economic activity in 2024 but could also have longer-term detrimental effects on productivity. The usual mechanism stems from shrinking capital spending that hurts productivity. Yet recent research by Angelica Leigh, one of our 2023 Distinguished Fellows, suggests that other forces could be at play in diminishing worker productivity. Leigh’s work shows the effects of “mega-threats” on worker well-being and productivity, and U.S. elections are increasingly characterized by an increase in mega-threat language and imagery. This often-overlooked externality of American political life shows why businesses need to think beyond their capital spending budgets when faced with electoral uncertainty.
At the recent Frontiers of Business Conference, decision-makers returned time and again in their discussions to the theme of an accelerated pace of change. Artificial intelligence is the natural culprit, yet the conversation extended beyond new technology, focusing on areas including the continuous need for reskilling, shifts in worker attitudes, increasing prevalence of informational overload, geopolitical threats and uncertainties, and the challenges faced by middle management in dealing with competing priorities of senior management and employees. In 2024, the institute will produce a series of Kenan Insights, commentaries, videos and webinars and hold expert discussions, events and other activities to address how businesses can build resilience in the face of contemporary challenges. Scholars, practitioners and business leaders will share knowledge and best practices distilled from their research and real-world experiences to help distinguish cyclical trends from structural ones and highlight the opportunities and trade-offs inherent to building business resilience. We hope you will join us, and we invite you to stay tuned.
This post was updated Jan, 30, 2024, to reflect latest data.