In the race to tame inflation, the final mile is the hardest

Despite durably high inflation and an aggressive monetary tightening cycle, activity was solid in 2023, with household consumption and public spending in particular driving growth. In 2024, growth is set to moderate only slightly despite the effects of higher rates, thanks for the most part to a persistently tight job market (unemployment under 4% and a robust job creation rate as at Q1 2024) supporting household consumption. Tailwinds from continued income growth will be modestly offset by depletion of pandemic-era excess savings and fragilities among financially vulnerable households (as suggested by rising delinquencies on auto loans and credit cards). Purchasing power will also benefit from moderating inflation. After peaking at 9.1% in mid-2022, CPI inflation rapidly decelerated and has stabilised at around the 3% mark since mid-2023, i.e., above the Fed’s 2% target. However, PCE inflation (the Fed’s preferred measure) is on a clearer downward trend, and the labour market shows multiple signs of loosening despite strong job growth. The Fed is therefore still expected to start cutting its target rate range (currently at 5.25%-5.50%, its highest since 2001) during the summer of 2024, albeit at a more cautious pace. These rate cuts would stimulate residential investment in the second half of the year. Nevertheless, financial conditions will remain restrictive in 2024 and weigh on corporate spending. Incentives to invest in clean energy and semiconductors should continue to keep capital expenditure afloat. While public spending was buoyant in 2023, it is likely to be more cautious this year. Rising interest charges on debt and divergent views on fiscal policy in Washington, especially in an election year, will limit federal spending. State and local governments, on the other hand, will continue to implement federal investment programs, including infrastructure, thus maintaining a positive contribution from public spending. The surprising boost to activity from net exports in 2023 is likely to run out of steam on back of the delayed effects of a strong dollar, which has further room for appreciation if other major central banks loosen policy faster.

Fiscal deficit stabilises at a high level

Falling government revenues following atypical growth in the previous fiscal year, and rising debt servicing costs contributed to a widening deficit in 2022-23. In the current fiscal year, the deficit is expected to narrow again, although it will remain well above the deficits recorded prior to the Covid-19 crisis. Under the Fiscal Responsibility Act of June 2023, which ended the debt ceiling crisis, non-defence discretionary spending would therefore remain unchanged. After the elections, a re-elected Biden would face pressure from Republican lawmakers to extend the 2017 Trump tax cuts and offset their impact with spending reductions. However, with most of the growth spending coming from debt service costs and demographically driven welfare and healthcare spending, the margin for meaningful consolidation is thin. A return to office by Trump could result in the Republicans controlling both houses of Congress, which would herald an extension of the 2017 income tax provisions and a further cut in the corporate tax rate. To compensate, we would expect to see adjustments in Biden’s green policies, more selective welfare, and a reduction of health insurance subsidies. In any scenario, large deficits are expected to persist. Although the debt burden is heavy, the authorities remain in a position to meet their financial obligations given the country’s unrivalled financing flexibility thanks to its status as issuer of the USD, the world's main reserve currency. However, the last-minute agreement to raise the debt ceiling in 2023 to avoid default demonstrated that politicisation of the debt limit is a recurring pitfall. This was one of the risks cited by Fitch to justify downgrading the US’ credit rating to AA+ in August 2023.

The current account deficit will remain high in 2024, fuelled mainly by the structural deficit in the merchandise balance (3.9% of GDP in 2023). New liquefied natural gas production capacity will support exports, particularly to Europe. After experiencing significant movements linked to disruptions in transport services in recent years, the surplus on the services account should remain stable at around 1% of GDP. The positive primary income balance (0.7% of GDP) is expected to improve slightly, as receipts from interest and deposits on US assets abroad increase. International cooperation transfers and remittances will keep the transfer balance in deficit (around 0.6% of GDP). The attractiveness of US assets and the USD is generating portfolio investments (Treasury bills, equities, etc.) to finance the deficit. Any post-election trade policy (such as higher tariffs) is unlikely to affect the trade deficit, as it originates from the US’s structurally high levels of consumption relative to production.

2024 elections set against a backdrop of high-running domestic and international tension

Incumbent Democrat Joe Biden and his Republican Predecessor, Donald Trump, have both won their respective primary races and are on course for a rematch of the 2020 contest. Concerns over Biden’s age and Trump’s legal dilemmas are unlikely to obstruct their candidacies. The race for the Presidency will be closely contested, as will those for the House of Representatives and the Senate. As neither party is expected to win the trifecta, we expect a divided Congress. In a polarised political context, the leanings of each candidate point to divergent outlooks on domestic and foreign policy. A second Trump presidency would be marked by less reliable support for key allies (Ukraine, Israel, NATO), tighter immigration policies, tax policies favoring fossil fuels and corporations, and increased trade tariffs. Under a continued Biden administration, we expect a stronger focus on industrial policy (with a preference for green policies), a push for tax hikes on corporations and high-income households, and a multilateral approach to foreign policy.

In an environment of heightened technological competition, and with tensions in the China Sea remaining high, rivalry with China continues to dominate US foreign policy and is likely to remain a priority whatever the outcome of the election. The commitment to Ukraine would be uncertain under Trump, though Senate Republicans will favour continued support. The alliance with Israel should remain strong in either case, but efforts to contain Israeli military action and avoid an escalation of the conflict will remain in place.