Bank of America's latest economic outlook for the U.S. paints a complex picture of steady but gradually fading economic growth, persistent inflation and a delayed start to the Federal Reserve's rate cuts.
The bank's economist, Michael Gapen, emphasizes a "higher-for-longer" rates environment, with the first rate cut expected only in December.
Bank of America expects the factors that have driven the U.S. economy's outperformance in recent years - such as robust labor force growth, employment catch-up effects, supportive fiscal policies and increased domestic manufacturing investment - to gradually fade.
The bank projects a slowdown in real GDP growth from 3.1% in 2023 to 2.1% in 2024, 2.0% in 2025 and 1.8% in 2026. Modestly restrictive financial conditions, tighter bank lending standards, diminishing wealth effects and a strong dollar are seen as significant headwinds.
Persistent Inflation Concerns
Inflation is expected to decelerate but remain sticky, particularly in the services sector. Gapen notes that while the rebound in the labor force exerts positive supply effects on inflation, it also leads to greater employment, income, and spending, which maintain demand pressures.
Core PCE inflation is forecasted to end 2024 at 2.8%, before slowing to 2.3% in 2025 and 2.1% in 2026.
"The combination of stronger growth and sticky inflation has led us to embrace high-for-longer rates," Gapen explains, highlighting the resilience of the U.S. economy as indicative of higher neutral rates than pre-pandemic levels.
Delayed Rate Cuts and Fiscal Moderation
The higher-than-expected inflation in the first quarter has delayed the rate-cutting cycle. Bank of America now expects elevated year-on-year rates of core PCE inflation through the end of 2024.
The terminal rate in this easing cycle is projected to be between 3.50% and 3.75% in 2026.
"Our outlook has a higher-for-longer flavor, with later and fewer cuts than many expect, in order to keep inflation on a downward trajectory," Gapen notes.
The bank also anticipates a moderation in fiscal policy and business investment growth.
Recent data suggest this moderation is already occurring, with the contribution from government spending to GDP at only 0.2 percentage points in Q1 2024.
Following an underwhelming tax season, the fiscal year 2024 deficit has been revised up to $1.8 trillion (6.3% of GDP), from the previously expected $1.62 trillion (6.0% of GDP).
Market Forecasts And Risks Ahead
On the market front, Bank of America expects the S&P 500 index, as tracked by the SPDR S&P 500 ETF Trust
Analysts are bullish on gold, as monitored through the SPDR Gold Trust
"Our forecast could easily be described as a gilded glidepath: it's close to perfection in every dimension. Won't something go wrong?," Gapen wrote.
Bank of America acknowledges several risks to its forecast, including a faster-than-expected end to catch-up employment, rising inflation prompting more Fed tightening, inefficiencies from an industrial-policy-led investment boom, geopolitical risks, and the upcoming elections.
The upcoming U.S. election is also highlighted as a potential wildcard, with significant implications for the economy.
Michael Hartnett, Bank of America's chief investment strategist, points out that the 2024 election will be the first in 30 years where Baby Boomers are not the majority voting bloc.
Key issues for younger voters, such as inflation, healthcare, and housing, could shape fiscal policies and markets going forward.
