The U.S. economy ended 2024 on a high note and the outlook looks promising for 2025. Recent performance shows the economy is on solid footing and has been growing at a steady pace and above its historical average. The labor market is healthy, unemployment is low, inflation has fallen almost to the Federal Reserve’s target even though it remains somewhat sticky, and the direction of interest rates remains lower.
Gross domestic product grew at an annual rate of 3% in the second quarter and the Bureau of Economic Analysis recently revised third-quarter GDP growth to 3.1% from 2.8%. Those numbers plus monthly data seen so far from the fourth quarter put 2024 on pace to expand by 2.7%, easily topping the historical average of 2%. The year was marked in large measure by the impressive resiliency of the consumer and a sturdy labor market. Consumer spending was supported by low unemployment and also by wage gains, which have outpaced inflation even as employers have slowed hiring. The Personal Consumption Expenditures Price Index – the Federal Reserve’s preferred measure of inflation – was up 2.4% year over year in November, close to the Fed’s goal of 2% and substantially less than the 3.9% year-over-year increase in wages measured by the quarterly Employment Cost Index.
During the first two months of the final quarter of 2024, consumers continued to show their ability to spend, with spending on both goods and services growing 5.5% year over year unadjusted for inflation. Disposable personal income was up 5.2% year over year, much faster than in late summer, and helped boost consumer purchases. The holiday spirit may also have provided some extra energy. Core retail sales as defined by NRF – excluding automobile dealers, gasoline stations and restaurants – confirm that U.S. consumers continue to spend at a healthy clip. Core retail sales were up 4% unadjusted year over year on a three-month moving average as of November and up 3.8% for the first 11 months of the year. While December figures have yet to be released, spending is on track to meet or exceed NRF’s projection for sound holiday shopping season growth between 2.5% and 3.5% over 2023.
Recent nonfarm payroll gains and expected strong earnings growth should keep the economic expansion on a sturdy foundation. Nonfarm payroll employment rebounded sharply in November, expanding by 227,000 jobs after being curtailed by back-to-back hurricanes and labor strikes in October. The trend in the labor market is toward slower growth but it remains sturdy. Employment growth is positive, hours are up and wages are as well. Average hourly earnings In November were up to 4.4% from 4.2% from October on an annualized three-month average and average weekly hours improved to 34.3 in November from 34.2 in October. Weekly unemployment claims continue to be an excellent real-time monitor of labor market conditions. New filings dropped slightly to 211,000 in the week ending December 28 from 219,000 in the prior week while the four-week moving average edged lower to 223,500. The numbers show slower hiring but are low and stable. Continuing claims for unemployment insurance fell to 1.8 million in the week ending December 21 and were only about 40,000 higher than a year earlier. This measurement has been creeping up over the past year but does not appear to be accelerating higher than what would be typical for a slowing labor market.
The disconnect between strong consumer spending and weak consumer confidence has been an important story in the past year. The lingering pessimism is likely due to consumers seeing prices that are higher than they were before the pandemic while housing costs continue to be elevated, even though most inflation is now in services rather than goods. The University of Michigan’s consumer sentiment index remains low but has been climbing in recent months. Consumer sentiment rose for the fifth consecutive month in December, improving 3.1% to an index of 74, the highest level since April. Nonetheless, buying expectations rose a significant 32%, with consumers expecting higher future prices for large purchases, and the overall sentiment reading is between the all-time low of June 2022 and pre-pandemic averages. Consumers believe that while inflation has slowed they are still not thriving and clearly need lower prices to restore their confidence.
I don’t want to get ahead of our annual forecast, but there is good reason to expect healthy economic growth in 2025 even though its shape will depend upon a lot of moving parts. The economy is expected to grow between 2% and 2.5% in 2025 but the range of uncertainty is wide, and this estimate could change. It is unclear what changes to trade, immigration, regulation, tax and spending policies will be adopted and how they could help or hinder the flow of economic activity. There will be many crosscurrents affecting economic performance, but the resilience of the U.S. consumer should hopefully remain part of the dominant narrative.
These potential changes and uncertain timing along with other data have prompted the Fed to pull back on interest rate reductions expected in 2025. Inflation has fallen sharply since the middle of 2023, but the pace of price changes has been uneven and is currently stalled. The Fed lowered interest rates by a quarter of a point at its final meeting of 2024 and acknowledged that with the path forward more uncertain, cuts are likely to move much more slowly in 2025. The Fed continues to attempt to thread a needle of lowering rates but at a pace that won’t undo recent progress on inflation. Fed officials’ quarterly projections for where interest rates are headed show just half a percentage point in cuts are likely to come in 2025. That is notably different than September projections that implied a full one-point reduction across eight meetings scheduled for 2025.