U.S. economic outlook: Our scenarios

In our baseline scenario, we anticipate that growth remains solid, continuing at or above the long-term U.S. growth trend of 1.8% even after the economy cools because of the impact of past rate hikes and the midyear backup in long-term yields. We give this scenario a 50% probability of taking place.

We think monthly hiring will cool to around the long-term level of 75,000 per month through the year. But as inflation eases, real wage growth will continue to improve, putting a floor underneath an economy that continues to adjust to a higher-for-longer price level and the rising yields across the maturity spectrum. 

As the economy cools, we expect the Federal Reserve to bring down the federal funds rate by 100 basis points to stabilize long-term real yields and provide relief on borrowing costs for small- and medium-sized firms.

While we expect excess savings to be largely exhausted sometime in the first or second quarter of the year, we anticipate a modest increase in the unemployment rate to 4.2% and the expansion to continue. 

Upside alternative to the baseline: 25% probability

In one of our alternatives to the baseline, the economy will prove to be far more resilient than expected, with growth approaching 2.5%.

The combination of excess savings, which we have estimated to be as high as $1.3 trillion, strong job demand and rising real wages amid soaring productivity will propel an unexpectedly strong U.S. economy.

Under this scenario, the major surprise will be the impact of large firms’ integrating sophisticated technology, most notably artificial intelligence, which will turbocharge output amid restrained labor costs.

Inflation during the last six months averaged 3.5%—well above the 2.3% between 2003 and 2013 and closer to the 2.8% average between 1993 and 2003.

With price stability returning, the Fed will hold off on any rate cuts until core inflation is back near 2.5%, most likely in late 2024 or early 2025.

Downside alternative to the baseline: 25% probability

In our third scenario, which we see as less likely, spending is pulled into the year’s final quarter amid the exhaustion of excess savings, a Fed policy error on hiking rates further and elevated borrowing costs. Those dynamics would create the conditions that tip the economy into a shallow recession in early 2024.

Under this scenario, weak holiday spending demand would create the conditions for an inventory correction that stimulates a greater-than-expected increase in unemployment and firms a pullback on software, equipment and intellectual property investments. Productivity gains, in turn, would slow back to or below the 1.3% trend of the past decade.

The Fed would then cut rates to offset a modest economic contraction as inflation moves back toward the long-run 2% target. Under this set of economic conditions, the Fed would start to cut the rate by 150 to 250 basis points during the first quarter to bring the federal funds rate down to the neutral level of 3% to 3.5% much more quickly.