Can The Economy Cope With Higher Interest Rates In 2024?

The latest Investing and Finance Report from Morningstar for Q1 2024 and onwards.
Complete with Updated graphs and charts.

a) Forecast Update
b) Economic Overview
c) Consumer spending
d) Investing
e) Labor
f) Inflation
g) Monetary, Fiscal & Financial
h) Appendix

U.S. Economic Outlook Q1 2024.
Morningstar

1. Important Disclosure
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Morningstar Equity Research
US Economic Outlook: Q1 2024
Can the economy cope with higher interest rates?
Preston Caldwell
Chief US Economist
ECONOMIC OUTLOOK | FEB. 28, 2024
Yuyang Zhang
Associate Equity Analyst, Markets and Economics

2. Table of Contents
Forecast Update: Consensus Has Shifted Closer to
Our Optimistic Views
Economic Overview: Productivity Rebound Helping
to Enable Soft Landing
Consumer Spending: Growth to Trend Down as
Excess Savings Expire
4
9
14
US ECONOMIC OUTLOOK | Q1 2024
18
22
29
Investment: Artificial Intelligence Hype Not Yet
Creating an Investment Boom
Labor:Slowdown in Job Growth to Renew in Later
2024
Inflation: Return to Normal Is Close
37Monetary, Fiscal, and Financial: Fed to Start
Cutting Rates in Mid- 2024

3. Morningstar Equity Research | 3
Key Takeaways
Source: Bureau of Economic Analysis, Survey of Professional Forecasters, Morningstar.
Inflation Versus GDP Growth ScenariosOur Inflation Optimism Is Playing Out
Inflation has dropped by around 4 percentage points over the past year even as real
gross domestic product growth has accelerated. That combination is contrary to the
usual positive relationship between these variables; it reflects the dramatic supply-side
improvement that we had called for a year ago. This includes clearing of bottlenecks
affecting specific industries (energy, autos) as well as general improvement in labor
supply and productivity. We expect the US economy to enter and stay in the " soft
landing"zone, with inflation an average 1.9% over 2024-28, while avoiding a recession.
Are Higher Interest Rates the New Normal?
While the economy has seemed nearly impervious to the effects of rate hikes so far, we
think a greater slowdown is coming as the strain of rate hikes continues to accumulate.
We expect GDP growth to slow significantly in 2024 and 2025, and we expect large
federal-funds rate cuts to be needed to propel a rebound in growth in the latter half of
2025 and following years. The forces that have driven real interest rates lower for
decades (such as demographics) haven't abated. We don't think the economy can
preserve itself for long on a diet of high rates.
US ECONOMIC OUTLOOK | Q1 2024

4. US ECONOMIC OUTLOOK | Q1 2024
Forecast Update
Consensus Has Shifted Closer to Our Optimistic Views

5. Morningstar Equity Research | 5
FORECAST UPDATE
We Still Expect Inflation to Plummet, Allowing the Fed to Cut Rates and Jump-Start GDP Growth
GDP Forecast Revisions
Inflation Forecast Revisions
We Expect Growth to Trough Over Next Two Years but Rebound Thereafter
We've again added to our expectations of near-term (2024) GDP growth while pulling
back on 2025 and 2026 growth to account for delayed risks to the demand side of the
economy from monetary policy and other factors. Admittedly, the economy has proven
surprisingly resilient to rate cuts. Record highs in equity prices, other improvement in
financial conditions, and supply-side expansion have offset the hit from high interest
rates. But we still see large downside risks over the next few years if rates remain high,
as the strain of high interest burdens will accumulate as debt is rolled over and balance
sheets deteriorate. Fortunately, we expect the Fed to respond nimbly to falling inflation
and weakening growth in 2024 and 2025 by cutting interest rates aggressively, thereby
triggering a growth rebound in 2025 and 2026.
Inflation Should Return to Normal in 2024
Our inflation forecast hasn't changed much compared with a month ago. While
economic growth is running strongly, inflation data is nevertheless heading down in line
with our expectations. In fact, the month-over-month data has shown inflation in line
with the Fed's 2% target over the past six months. For the full- year data, we expect a
return to the Fed's 2% target in 2024, with the Fed even undershooting its target in 2025.
A combination of easing supply constraints and Fed tightening is winning the battle
against inflation.
Exhibit Sources: Morningstar.
Current ForecastJanuary 2024 Forecast
2024 2025 2026 2027 2028
0.0
1.0
1.5
2.0
2.5
2.0
1.9
1.6 1.6
1.8
1.7
1.9 1.9
2.0 2.0
Current ForecastJanuary 2024 Forecast
2024 2025 2026 2027 2028
0.0
2.0
3.0
4.0
2.0
1.8
1.5
1.7
2.6
2.8
3.0
2.8
2.6
2.4

6. Morningstar Equity Research | 6
FORECAST UPDATE
Consensus has Shifted Closer to Our Optimism on Strong GDP Growth and Mild Inflation
Real GDP Forecast Comparison
Inflation (PCE) Forecast Comparison
We Start Off More Pessimistic on Growth, but End More Optimistically
In 2024 and 2025, our GDP growth views are slightly below consensus views, which
have responded to near-term strength in the data with upward revisions, but we think
consensus is underrating downside risks.
We're slightly upbeat on growth in the longerrun, as we expect a cumulative 2% more
real GDP growth through 2028 than consensus does. This is because of our optimism on
labor supply growth, including labor force participation rates. Consensus has shifted
closer to our views on this five-year time horizon owing to recent revisions, but a gap
remains.
We Expect Inflation to Fall a Bit Greater Than Consensus
On inflation, consensus has shifted heavily toward our inflation optimism, although we
differ in expecting inflation to run slightly below the Fed's 2% target in 2025 and (to a
lesser extent) 2026. This is owing to our view that the economy will be running a good
deal below potential in 2025, and this slack should generate hefty disinflationary
pressure.
Exhibit Sources: Survey of Professional Forecasters, Morningstar.
MorningstarConsensus
2024 2025 2026 2027 2028
0.0
1.0
2.0
3.0
2.0
2.1
1.6
2.0
1.8
2.0
1.9
2.0 2.0 2.0
MorningstarConsensus
2024 2025 2026 2027 2028
0.0
2.0
3.0
4.0
2.0
2.4
1.5
1.8
2.6
2.2
3.0
1.7
2.6
1.7

7. Morningstar Equity Research | 7
FORECAST UPDATE
Interest Rates Will Soon Be Headed Back Down
Source: Federal Reserve, Morningstar.
We Expect the Fed to Shift Back to Easing in 2024
Interest rates have soared over the past year as expectations of monetary policy
tightening have built up and begun to play out. However, we think the Fed will receive
the green light from falling inflation to pivot back to easing in mid-2024. The Fed will
need to lower interest rates to avert a greater fall in housing activity and eventually
generate a rebound. This should allow GDP growth to reaccelerate in late 2025 and
2026. By 2027, we expect monetary policy with a neutral stance, with the federal-funds
rate and the 10- year Treasury yield in line with our assessment of their long-run natural
levels.
We have delayed our expectations for federal-funds rate cuts slightly, as we’re now
expecting a May or June 2024 first rate cut versus March previously. But we still see
interest rates pushing below market expectations. The five-year Treasury yield stands at
4.3%, implying an average federal-funds rate of around 4% over the next five years. By
contrast, we expect an average effective federal-funds rate of about 2.7% over the next
five years. Likewise, the 10- year Treasury yield is 4.3%, significantly above our long-run
projection of 2.75%. The narrative that the US economy has shifted to a prolonged
higher-interest-rate regime versus prepandemic rates is incorrect, in our view.
Interest-Rate Forecasts (Annual Average)
Federal-Funds Rate10-Year Treasury30-Year Mortgage
201720182019202020212022202320242025202620272028
0
2
3
4
5
6
7
20242025202620272028
Fed Funds Rate5.02%3.29%2.06%1.88%1.88%
10-Year Treasury4.00%3.00%2.75%2.75%2.75%
30-Year Mortgage6.50%5.00%4.50%4.25%4.25%

8. Morningstar Equity Research | 8
FORECAST UPDATE
Our Supply-Side View Drives Our Bullish View on GDP
Exhibit Sources: Bureau of Economic Analysis, Morningstar.
We Expect More Labor Force Expansion Than Consensus
Our longer- run GDP forecast is determined solely by our projections for the supply side
of the economy, as we expect the Fed to calibrate aggregate demand, so the economy is
operating at full capacity. GDP growth in the prepandemic years was fueled heavily by
cyclical labor market expansion (the long recovery from the Great Recession). So, we
can't take for granted that prepandemic growth rates represent a good benchmark for
long-term growth.
Our bullish view on GDP through 2027 compared with consensus is driven greatly by our
expectations for labor supply. We expect labor force participation (adjusted for
demographics) to recover ahead of prepandemic rates as widespread job availability
pulls in formerly discouraged workers. Consensus expects labor force participation to
struggle to reach prepandemic rates.
Productivity growth has averaged about 1.4% since the start of the pandemic, and we
expect about 1.4% growth over 2024-27. USReal GDP Growth: Supply-Side Decomposition
Labor Productivity: real GDP/total hours worked
Hours Per Worker: total hours worked/total employment
Employment Rate: total employment/labor force … also equal to 1 minus the unemployment rate
Labor Force % of Potential: labor force/"potential" labor force
Potential Labor Force: derived from our estimates of cyclically neutral labor force participation rates for
each age group in the population
0.6%
0.5% 0.5% 0.5%
0.4%
0.3%
0.5%
0.2%
1.1%
1.4%
1.4%
1.6%
2.5%
2.0%
2.4%
2.1%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
2014-19 CAGR2019-23 CAGR2023-28 CAGR2028-33 CAGR
Labor
Productivity
Hours Per
Worker
Employment
Rate
Labor Force
% of
Potential
Potential
Labor Force
GDP
Cyclical
Labor
Factors

9. US ECONOMIC OUTLOOK | Q1 2024
Economic Overview
Productivity Rebound Helping to Enable Soft Landing

10. Morningstar Equity Research | 10
ECONOMIC OVERVIEW
Despite Resilience in Economic Activity, We Expect Growth to Weaken Until Fed Pivots to Rate Cuts
Real GDP by Expenditure, % Quarter- Over-Quarter Growth (Annualized)
GDP Growth, Quarterly Forecast
GDP Growth Remains Solid in Q4
After having surged to 4.9% in third-quarter 2023, real GDP growth posted a solid 3.2%
(quarter over quarter, annualized) in the fourth quarter. The third- quarter number had
been boosted by several temporary factors, including inventory accumulation. In the
fourth quarter, net exports unexpectedly swung upwards, contributing 40 basis points of
growth. Government spending growth also was a persistent tailwind in 2023, but that's
set to change in 2024. Consumption growth of 3% could underpin ongoing solid growth
if it continues, but we're expecting consumers to become more cautious in 2024.
We Expect Growth to Weaken Before Bouncing Back in 2H2025
We believe several factors will weigh on economic growth over the next year. The
impact of higher interest rates has yet to be fully felt in the economy. For example, bank
credit issuance has responded with a delay and has further to contract. Another factor
that will eventually weigh on growth is the depletion of household excess savings.
However, we expect aggressive interest-rate cuts by the Fed to trigger a growth
rebound.
Exhibit Sources: Bureau of Economic Analysis.
2021 2022 2023
-4
0
2
4
6
8
10
Total
Personal
Consumption
Private Fixed
Investment
Government
Net Exports
Inventories
Year over yearQuarter over quarter (annualized)
2023 2024 2025 2026
0
2
3
4
5

11. Morningstar Equity Research | 11
ECONOMIC OVERVIEW
US Real GDP Has Soared Above Its Prepandemic Mark, Lifted by Consumption
US real GDP stands about 8.2% above fourth-quarter 2019
levels. This amounts to a 2.0% average annual growth rate,
only modestly below the prepandemic average (2.5%
average GDP growth over 2015-19) and in line with the
roughly 2% average growth that forecasters had been
projecting on the eve of the pandemic.
The economy's rocketing recovery in 2021 was fueled by
consumer goods, although the balance shifted to
consumer services in 2022 and 2023. All together,
consumption has increased at a 2.5% annual rate since the
fourth quarter of 2019. Net exports have been the main
drag.
Residential investment contribution has shifted from
positive to slightly negative, but the magnitude of this shift
is far smaller than the housing boom and bust of the
2000s.
Exhibit Sources: Bureau of Economic Analysis.
GDP by Expenditure, % Cumulative Growth Versus Q4 2019
2020Q2Q3Q42021Q2Q3Q42022Q2Q3Q42023Q2Q3Q4
-10
-6
-3
0
3
6
10
Total
Consumer Goods
Consumer Services
Residential
Investment
Business
Investment
Inventories
Govt
Net Exports

12. Morningstar Equity Research | 12
ECONOMIC OVERVIEW
Productivity Rebound Should Continue in Coming Years
Source: Bureau of Economic Analysis, Morningstar.
Productivity Dipped in 2022,but Has Recovered Strongly in 2023
Back in the first half of 2022, GDP declined even as employment growth blazed away,
causing a dip in measured productivity. We had expected the drop in productivity would
be temporary (reflecting supply-side disruptions), and that's played out. Real GDP was
up 3.1% year over year in fourth -quarter 2023 and labor supply (total hours worked) was
up 1.2%—this equates to measured productivity growth at an impressive 1.9%.
The rebound in productivity may help explain strong GDP growth in 2023 in the face of
rate hikes, insofar as supply is creating its own demand. The improvement in
productivity has helped put downward pressure on prices, allowing real wages to grow
and workers to consume more.
Partly because productivity is growing strongly, there is room for the Fed to achieve a
phase of "below-potential"GDP growth that is still in positive (nonrecessionary) territory.
This is our expectation for what happens in 2024 and 2025, helping to win the rest of the
battle against inflation. Because productivity will remain strong, deceleration of GDP
growth does mean that companies' labor needs will decline a bit. Thus, we expect
employment to decline slightly and the unemployment rate to tick up from 3.8% in the
fourth quarter of 2023 to 4.3% by fourth-quarter 2024 and an average 4.4% in 2025.
GDP by Supply-Side Factor, % Cumulative Growth Versus Q4 2019
Real GDPLabor ProductivityHours Worked
2020 2021 2022 2023 2024 2025
-16
-12
-8
-4
0
4
8
12

13. Morningstar Equity Research | 13
ECONOMIC OVERVIEW
We Expect the US Economy to Achieve a Soft Landing
Source: Bureau of Economic Analysis, Bloomberg, Morningstar.
Four Near-Term Scenarios for the US Economy
Our base case is that inflation will return to normal in 2024, even as real GDP growth
remains positive in year-over-year terms. This puts us within the "soft landing"camp,
one of four main scenarios for the US economy in the next couple of years.
Over the past six quarters, inflation has fallen almost 400 basis points even as real GDP
growth has accelerated. That performance has defied the predictions of the
"stagflationistas,"who thought that a deep economic slump would be needed to
eradicate entrenched inflation. Instead, the inflation-GDP tradeoff has been very kind
thanks to loosening of supply constraints, as we had long anticipated.
Where we've been surprised is the resiliency of economic growth in the face of
aggressive rate hikes from the Fed. This means the "overheating"scenario has increased
in probability, where the economy grows at a rollicking pace and inflation remains in the
3%-4% range. We still think that the Fed's rate hikes executed thus far will eventually
slow GDP growth sufficiently that inflation will drop all the way to 2% (while avoiding an
outright recession). Supply-side improvement will continue to play a supporting role. The
Fed increased the federal-funds rate by over 500 basis points in a little over a year, the
largest such move in 40 years. The effects of these rate hikes are still accumulating
throughout the economy as borrowers roll over to higher interest rates and financial
cushions are progressively exhausted.
Inflation Versus GDP Growth Scenarios

14. US ECONOMIC OUTLOOK | Q1 2024
Consumer Spending
Growth to Trend Down as Excess Savings Expire

15. Morningstar Equity Research | 15
CONSUMER SPENDING
Consumption Growth Strengthened in 2H 2023, but We Expect Gradual Downtrend
Real Personal Consumption, % Growth (Three-Month, Annualized)
Real Personal Consumption, % Cumulative Growth Versus January 2020
Consumption Growth Rebounds Temporarily
Real consumption growth was 3.0% in fourth-quarter 2023, holding steady versus the
3.1% in the third quarter. A strong rebound in goods pushed overall consumption up
in the second half of 2023, probably aided by supply chain relief reducing prices and
making goods more widely available. The about 25% rise in equity prices in 2023 also
probably boosted real consumption on the order of 1% (estimates of the wealth effect
vary).
Presaged by weak retail sales figures in January, we expect quarter-over-quarter
consumption growth to slow to around 1.5% in 2024. Depletion of excess savings,
along with the weakening in GDP growth and eventual deceleration in job growth
that we expect should induce morecautious behavior.
Goods-Services Consumption Patterns Nearing Normalization
We measure the return to "normal"for US consumers by comparing goods and services
consumption with their prepandemic trends. The convergence in real spending patterns
has slowed this year compared with the drastic narrowing of the gaps throughout 2021
and 2020. It now looks like the process of normalization is about wrapped up, with
further relative convergence of goods and services to their prepandemic trends being
minimal.
Exhibit Sources: Bureau of Economic Analysis.
ServicesTrend ServicesGoodsTrend Goods
2020 2021 2022 2023
–20
–5
5
15
25
GoodsServicesTotal
2022 Apr July Oct 2023 Apr July Oct 2024
–4
0
2
4
6

16. Morningstar Equity Research | 16
CONSUMER SPENDING
Exhaustion of Excess Savings Will Push Households to Cut Back on Spending
Personal Income and Spending, % Cumulative Growth Versus January 2020
Estimates of Excess Savings, $ Billion
Savings Rate Remains Far Below Prepandemic Levels
After having accumulated a massive stockpile of excess savings in 2020 andearly 2021
in addition to boosts by fiscal stimulus, consumers have been on an extended spending
binge as theydrawdown those excess savings. The personal savings rate reached a
nadir of 3.2% in third -quarter 2022—almost as low as during the spendthrift era of the
mid-2000s housing boom. Although the savings rate started ticking upward in the first
half of 2023, it dropped to 4.0% in the fourth quarter, down from 5.1% in the second.
Personal savings remain significantly below the prepandemic (2019) average of 7.4%.
How much longer will the excess savings last? Depending on which baseline savings
rate we use, the answer is sometime between mid-2024 and 2025. Regardless of the
exact figures, with the stockpile of excess savings dwindling, this should put upward
pressure on savings rates and help to slow consumption. Furthermore, some research
suggests that the bulk of remaining excess savings are held exclusively with higher
income households. Some households who've depleted their excess savings dipped
heavily into credit card debt in 2022 and 2023, but growth in balances is slowing and
delinquencies rising.
Exhibit Sources: Bureau of Economic Analysis.
2017-19 Avg Savings Rate2019 Savings Rate
2020 2021 2022 2023
0
1,000
1,500
2,000
2,500
Disposable Personal IncomePersonal ConsumptionSavings Rate
2020 2021 2022 2023
-20
0
20
40

17. Morningstar Equity Research | 17
CONSUMER SPENDING
Almost Everything Is Returning Fully to Normal
Personal Consumption Expenditure (Real), % Growth
Goods Share (%) of Personal Consumption (Nominal)
Goods-Services Mix Expected to Return to Prepandemic Levels by 2027
In 2023, the services share of nominal personal consumption (67%) was still slightly
below its prepandemic level (69%), while the goods share remains above. But outsize
deflation in goods prices relative to services will push down the goods share of total
consumption to its prepandemic level by 2027. The return to normal in terms of the
goods/services spending mix is essentially wrapped up.
The degree to which goods spending could drop in the near term is up for debate. Some
expertsposit that households may be already saturated with all different types of goods,
so they would allocate more of theirmoney toward the services consumption forgone
during the pandemic. By this logic,the real growth in goods consumption should be
more negative.
However, we believe this effect described above will be offset by other factors. First,
thepandemic will inevitably leave some permanent impacts on consumer behaviors,
such as some people shifting to less services- centric lifestyles. Second, it is unrealistic to
make up for all the forgone services consumption because time is finite. For example, we
have limited out-of-office days to "revenge spend"on travel to fully compensate for the
missed vacations during the pandemic years. Therefore, we do not expect the services
share to drastically outperform the goods share of spending in the near term.
Exhibit Sources: Bureau of Economic Analysis.
GoodsServicesTotal
2016201720182019202020212022202320242025202620272028
–8
0
4
8
12
1995 2000 2005 2010 2015 2020 2025
30
32
33
34
35
36
37

18. US ECONOMIC OUTLOOK | Q1 2024
Investment
Artificial Intelligence Hype Not Yet Creating an Investment Boom

19. Morningstar Equity Research | 19
INVESTMENT
Private Fixed Investment Likely to Slow in 2024 Under Strain of Higher Rates
Private Fixed Investment, % Share of GDP
Nonresidential Fixed Investment (Real), % Cumulative Growth Versus Q4 2019
Residential Investment Helped Offset the Pandemic Downturn
Investment spending is a major amplifier of booms and busts in the archetypal business
cycle, and it certainly played that role in the two recessions preceding the pandemic.
However, the pandemic downturn and recovery have been a very different story.
Business (private nonresidential) fixed investment was hardly hit by the pandemic in
aggregate. Residential investment boomed during the pandemic. It jumped to 4.8% of
GDP in 2021 from 3.8% in the fourth quarter of 2019, though it's since declined back to
3.9% under the weight of higher mortgage rates. Further declines are likely as long as
rates remain high, though we don't expect a Great Recession-size bust. Business
investment tends to lag in its response to monetary policy, and indeed we expect
nonresidential investment growth to slow in 2024.
Artificial Intelligence Hype Not Yet Creating an Investment Boom
Within business fixed investment, intellectual property investment remains very strong,
albeit only in line with its prepandemic trend. We'd expect to see this run much higher if
AI was having an appreciable impact on investment at the macro level. Structures
investment is nearing a full recovery to its prepandemic mark, buoyed by manufacturing
structures. We shouldn't be too surprised that high interest rates haven't smothered
business investment (yet). Historically, businesses often behave as if their cost of capital
is insensitive to short- term interest-rate fluctuations. However, they typically cut
investment at later stages of the business cycle as profits fall and credit availability
shrivels up.
Exhibit Sources: Bureau of Economic Analysis.
200220042006200820102012201420162018202020222000
0
8
12
16 Nonresidential
Fixed
Residential
2020 2021 2022 2023
–30
–10
0
10
20
30
Structures
Equipment
Intellectual
Property
Total

20. Morningstar Equity Research | 20
INVESTMENT
Investment Spending: Manufacturing Boom Is Providing a Near- Term Lift, but Bank Credit Contraction Is Looming
Manufacturing Structures Investment, % Share of GDP
Bank Loans, % Growth Year Over Year
Construction on Semiconductor and Clean Energy Factories Is Ramping Up
Investment in manufacturing structures has erupted to 0.8% of GDP as of fourth -quarter
2023, the highest since the early 1980s. The jump in spending has been driven mostly by
new facilities for semiconductor manufacturing along with clean energy equipment
(solar, batteries). Both industries are incentivized to build by profuse government
subsidies (Chips Act, Inflation Reduction Act). Many facilities broke ground in the past
year or so (such as Intel's Ohio fab in September 2022) and construction spending is
ramping up. Spending has reached a peak, so the incremental impact on growth will
likely be zero in 2024 and slightly negative in 2025 as projects begin to wrap up.
Exhibit sources: Bureau of Economic Analysis (top), Federal Reserve (bottom).
Bank Credit Has Much Further to Contract
Investment by the broader business sector (especially smaller businesses) is likely to be
hampered by a contraction in bank credit over the next year. Banks have been sluggish
to react to rising rates, but an adjustment is coming, as reflected in tightening credit
standards. Bank loan growth is decelerating but still up in year over year terms (even for
the vulnerable commercial real estate category), but we expect credit growth to sink
further over the next year. This credit contraction should weigh heavily on business
investment, particularly in commercial real estate structures.
2000 2005 2010 2015 2020
0.0
0.2
0.4
0.6
0.8
TotalCommercial Real Estate
Apr Jul Oct Jan
2023
Apr Jul OctJan
2022
0
6
9
12
15

21. Morningstar Equity Research | 21
INVESTMENT
Housing Boom Is Correcting, Helping Cool the Economy
Housing Activity Metrics
Housing Affordability Versus Housing Starts
Housing Activity to Remain Weak
Demand for housing skyrocketed during the pandemic, driven by record-low mortgage
rates, an increase in households' discretionary funds, and widespread uptake of remote
work. However,monetary tightening has led to a surge in mortgage rates since the start
of 2022, which has thrown cold water on demand. Housing starts fell 10% in 2023, and
we expect another 4% drop in 2024.
The excess of starts over completions in 2021 and 2022 has equated to the buildup of a
huge stockpile of uncompleted housing. As this stockpile is worked down over 2023 and
2024, the housing supply will continue to expand briskly even as construction activity
drops back, which should crush housing inflation.
Housing Affordability Has Severely Deteriorated
Soaring home prices were already weighing on housing affordability in 2021 as supply
was struggling to catch up with demand. Combined with the jump in mortgage rates
(around 400 basis points since the start of 2022), housing affordability is now at its worst
level since at least 2007. We believe only relief via much lower mortgage rates will allow
a sustained recovery in housing demand.
Exhibit Sources: Bureau of Economic Analysis, US Census.
Mortgage Payment % of Median IncomeHousing Starts
19751980198519901995200020052010201520202025
0
20
30
40
0
1,200
1,800
2,400
Residential Investment (Real)StartsCompletions
20152016201720182019202020212022202320242025202620272028
0
500
750
1,000
0
1,000
1,500
2,000

22. US ECONOMIC OUTLOOK | Q1 2024
Labor
Slowdown in Job Growth to Renew in Later 2024

23. Morningstar Equity Research | 23
LABOR
Slowdown in Job Growth to Renew in Later 2024
Nonfarm Payroll Employment, % Growth (Annualized)
Nonfarm Payrolls vs. Household Employment
Downtrend in Job Growth Has Paused Temporarily
Nonfarm payroll employment was 2.2% annualized in the three months through January
2024, a marked acceleration from 1.6% growth in the prior three months and the fastest
rate since first- quarter 2023. It's also slightly above the 1.7% average annual growth
over the prepandemic years of 2015-19.
One caveat is that the BLS' household survey provides a contrasting signal of
employment growth. The household survey is separate from the establishment (i.e.
employer) survey which provides the nonfarm payroll figures. While nonfarm payroll
employment is up 1.9% year-over-year as of January, household employment (adjusted
to make an apples- to-apples comparison with the former) is up merely 0.7%. The
cumulative growth gap between the two series since January 2020 has grown to 230
basis points.
Still, we generally think the establishment survey is more reliable, so it seems likely that
the downtrend in job growth that was in place over 2022 and 2023 has now paused. We
expect the downtrend to resume in the second half of 2024 in response to slowing
economic growth.
Exhibit Sources: Bureau of Labor Statistics.
3-month moving avgm / m
2021 2022 2023 2024
0
3
6
9
PayrollsHousehold
2020 2021 2022 2023 2024
–10
–6
–4
–2
0
2
4

24. Morningstar Equity Research | 24
LABOR
Drop in Average Hours Doesn't Necessarily Presage a Fall in Employment
Average weekly hours per worker was down 0.7% year
overyear as of January 2024, and has been declining for
the past two years altogether. At first the decline reflected
normalization after ultratight labor markets had caused
shifts to lengthen in 2021, but now average hours have
dipped below their prepandemic mark.
Some forecasters have suggested that firms' cutting of
hours is a prelude to cutting of jobs. However, after taking
a closer look at the evidence, we don't find hours to be a
strong predictive signal for employment.
1
The historical
data shows many false positives where shifts in hours do
not lead to corresponding shifts in employment levels.
Because of this, we've boosted our job growth
expectations for the first half of 2024.
Exhibit Sources: Bureau of Economic Analysis.
Average Weekly Hours and Nonfarm Payroll Employment, Cyclical Component
Chart guide: Using a Hodrick-Prescott filter, each series is decomposed into trend and cycle components, with the
cyclical components for each series shown here. The "average weekly hours" series is for production and
nonsupervisory workers, for which data stretches back to 1964. The sample shown here stops in 2019, as
estimation of the trend and cycle during the pandemic is distorted by data abnormalities.
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Recessions Average Weekly HoursNonfarm Payroll EmploymentStandard deviations
1 Running a vector autoregressive model on the cyclical components of hours and jobs over 1964- 2019, we find essentially zero influence of
lagged hours on employment.

25. Morningstar Equity Research | 25
LABOR
Industry Data Confirms Our View That Job Growth Should Fall
Employment by Industry Group, % Growth (Annualized)White Collar Hiring Rebounds
At the industry level, the recent acceleration in nonfarm payroll employment growth has
been driven chiefly by whitecollartype jobs, captured largely in the "other services"
category in the chart to the right. This includes jobs in information, professional services,
and management and administration. Firms had been cutting these jobs in a general
program of belt- tightening over the past year. Rising equity prices may be encouraging a
rebound in corporate hiring. Healthcare and leisure employment growth still leads the
way but is decelerating now that staffing has caught up with the shortfalls that had
developed in the postpandemic recovery.
Exhibit Sources: Bureau of Labor Statistics, Bureau of Economic Analysis.
Job Openings Rate Is Falling
The job openings rate has fallen significantly from its record 7.3% in March 2022 to an
average of 5.4% in fourth-quarter 2023. Though still above the 2019 average of 4.5%,
openings have decreased consistently over the past two years. While we don't put as
much stock as others do in job openings as a driver of excessive wage growth, it's still
encouraging to see normalizing openings, especially as employment levels have
continued to rise. Some economists thought that reducing job openings would decrease
employment. That hasn't been the case, probably because dislocations from the
pandemic, which are resolving, were what made job openings so high in the first place.
Job Openings Rate (% 3mma)
20042006200820102012201420162018202020222002
0
2
4
6
8
Aug-Oct 2023Nov 2023-Jan 2024
Construction
& Real
Estate
Manufacturing
& Mining
Retail &
Transportation
Healthcare
& Leisure
Other
Services
GovernmentTotal
–1.0
1.0
2.0
3.0
4.0
3.0
2.8
-0.3
1.5
0.21.0
3.7
3.3
-0.5
2.1
3.1
2.1
1.6
2.2

26. Morningstar Equity Research | 26
LABOR
Excesses of the Postpandemic Labor Market Have Normalized to a Great Degree
Hiring and Separation Rate % of Employees Three-Month Moving Average
Employment/Population Ratio, % Cumulative Change Versus January 2020
Quit Rates Normalize as "Great Reshuffling"Gives Way to Labor Hoarding
Employee quit rates dropped further to 2.2% in the fourth quarter, essentially back in
line with the prepandemic level of 2.3% after having peaked at 3% in early 2022. The
"Great Reshuffling"period of rampant job hopping is over. This signals a reduction in
workers' bargaining power, which has helped curb excess wage growth.
Layoffs remain very low at 1.0% in the past three months compared with around 1.2%
before the pandemic. Firms are still keen to hold onto workers given the recent painful
experiences labor shortages in 2021 and 2022.Because of low layoffs, net hiring has
remained positive even as gross hiring has dipped below prepandemic levels.
Lingering Shortfall in Labor Force Participation
The employment-population ratio is still 80 basis points below prepandemic levels,
according to the household survey. However, if we assumed that the establishment
survey rather than the household survey was the correct gauge of employment (see
Page27), then the employment/population ratio properly measured would be exceeding
its prepandemic mark (with the exact value depending on the extent to which population
growth is accurately measured). Taking the household survey at face value, the
remaining shortfall in the employment/population ratio is attributable to reduced labor
participation, mainly those aged 55 and older who retired early during the pandemic.
Exhibit Sources: Bureau of Labor Statistics.
TotalUnemploymentLabor Force Participation
2020 2021 2022 2023 2024
-10
-6
-4
-2
0
0 %
1 %
2 %
3 %
4 %
5 %
200120032005200720092011201320152017201920212023
Layoffs Other Quits HiringSeparations:

27. Morningstar Equity Research | 27
LABOR
Wage Growth Still Excessive but Normalizing
Private Hourly Earnings (Establishment Survey), % Growth (Annualized)
Wage Growth Measures, % Year Over Year
Don't Overreact to January's High Average Hourly Earnings Growth
The establishment survey's private average hourly earnings showed a rebound in wage
growth recently, up to 5.4% annualized in the last three months compared withjust
3.1% in the prior three months. Still, this figure can be fairly noisy. The January number
specifically may have been distorted by weather disruptions, which curtailed hours and
thus boosted per hour wages for salaried workers. The wage figures set off inflationary
alarm bells in the market, but this is probably an overreaction. Year-over-year growth in
average hourly earnings remained at a more restrained 4.5% as of January.
Moreover, our composite measure of wage growth still shows an overall downtrend,
with growth at 4.6% as of fourth-quarter 2023, down 150 basis points versus the peak in
early 2022. This composite includes four independent signals of wage growth. Assuming
productivity growth of 1.5% and a constant labor share of GDP, 4.6% wage growth is
consistent with inflation running at 3.1%. If the labor share of GDP is allowed to rise
(which would compensate for a drop in 2021 and 2022), inflation could run even lower.
Regardless, the labor market slowdown that we anticipate in later 2024 and 2025 should
easily return wage growth the rest of the way back to prepandemic rates.
Exhibit Sources: Bureau of Labor Statistics, Bureau of Economic Analysis.
3-month moving avgm / m
2021AprJulOct2022AprJulOct2023AprJulOct2024
0
3
5
7
9
2017 2018 2019 2020 2021 2022 2023
0
2
4
6
8
BEA Total
Compensation
Employment Cost
Index
Atlanta Fed
Private Wages
(Establishment)
Average

28. Morningstar Equity Research | 28
LABOR
Labor Market Slowdown Ahead, Followed by Rebound When Economic Growth Restarts
Exhibit Sources: Bureau of Labor Statistics, Morningstar.
We expect slowing economic growth to cause the unemployment rate to rise to 4.0% on
average in 2024 and 4.4% in 2025, from an average 3.7% in 2023. Growth in employment
slows to 0.6% in 2024 and 0.1% in 2025. This would be quite mild compared with US
economic slowdowns in recent decades, which is consistent with our expectation that
the US avoids a recession. Nonetheless, this cooling of the labor market should be
sufficient to return wage growth back to normal. Our unemployment forecast is slightly
higher than consensus, which projects a peak of 4.2% in 2025 (SPF).
After 2025, we expect labor markets to recover as economic growth reaccelerates, with
the unemployment rate hitting 3.5% (where it was before the pandemic) by 2028. We
expect the labor force participation rate (ages 16-plus) to hold steady through 2028,
which qualifies as "outperformance"given the aging of the population, which exerts
downward pressure on the participation rate. Our thesis was laid out in detail in our
US
Economic Outlook: Second- Quarter 2021(Page 18). As had been occurring over the
2015-19 period, we expect solid job availability to draw formerly discouraged people
back into the labor force. Most other forecasters, by contrast, expect the labor force participation rate to fall over the next several years.
Labor Market Forecasts
Unemployment rate (left axis)Employment / Pop Labor Force Participation Rate
2012 2014 2016 2018 2020 2022 2024 2026 2028
0
2
3
4
5
6
7
8
9
10
55
57
58
59
60
61
62
63
64
65

29. US ECONOMIC OUTLOOK | Q1 2024
Inflation
Return to Normal Is Close

30. Morningstar Equity Research | 30
INFLATION
Inflation Is Close to Returning to Normal
PCE Inflation Forecasts, % Growth
Inflation Measures, % Growth Year Over Year
We Expect Inflation to Return to 2% in 2024
After peaking at an average 6.5% in 2022 (the highest since 1981), PCE price index
inflation receded to 3.7% in 2023 and should soon return to normal. We forecast a 2%
inflation rate for 2024, with a 1.9% average over 2024 to 2028. The fall in inflation has
been driven principally by supply-side improvement, particularly in categories like energy
and durable goods where prices spiked in 2021 and 2022 and have fallen since then.
Restricted demand will play a greater role in depressing inflation in 2024 and 2025 given
our expectation of slowing GDP growth. Despite its initial tardiness in responding to high
inflation, the Fed has ultimately defended the credibility of its 2% price target, as
evinced by market inflation expectations.
Headline Inflation Has Plunged Since Mid-2022
In terms of the monthly numbers, PCE inflation has dropped from a peak of 7.1% year
over year in June 2022 to an estimated 2.3% year over year in January 2024, with core
PCE inflation at 2.8% year over year in January. Consumer price index (CPI) inflation is
running higher than PCE, owing chiefly to a greater weight to housing, where inflation
remains very high. We focus on the PCE index, given its methodology is superior to the
CPI and it's the index preferred by the Fed. Headline inflation has fallen to a greater
extent than core inflation, owing to falling energy prices versus a year ago.
Exhibit Sources: Bureau of Economic Analysis, Bureau of Labor Statistics.
CPICPI CorePCE PCE Core
2020 2021 2022 2023 2024
0
4
6
8
10
PCE CorePCE Total
2015 2017 2019 2021 2023 2025 2027
0.0
2.0
3.0
4.0
5.0
6.0
7.0
0.21.0
1.8
2.0
1.4
1.1
4.2
6.5
3.7
2.0
1.5
1.7
1.92.0

31. Morningstar Equity Research | 31
INFLATION
Downtrend in Core Inflation Should Continue as Components Largely Fall in Harmony
PCE Core Inflation by Components, % Growth (Annualized)
Core Inflation Rate Closing in on 2%
In terms of the month over month rate, core PCE inflation has already about returned to
normal, having averaged 2.3% annualized over the past six months. It's still a bit too
early to declare victory over inflation, and the Fed will want to wait for the year over
year core inflation rate to drop closer to 2% before cutting. Nonetheless, it looks highly
likely at this stage that inflation has been brought under control.
Stripping Out Housing, Inflation's Fall Is Even Greater
Housing remains the main contributor to continued high inflation. Excluding housing, the
core inflation rate was just 1.6% annualized in the last three months, and 2.0% year over
year. Housing inflation was 6.3% annualized in the last three months and has made little
downward progress after having dropped in the first half of 2023. But the leading-edge
data continues to indicate that housing inflation should soon return to normal.
Exhibit Sources: Bureau of Economic Analysis, Bureau of Labor Statistics.
PCE Core Inflation, % Growth (Annualized)3-month moving avgm / m
2021 2022 2023 2024
0
4
6
8
Core PCEHousingEx-Housing
2021 2022 2023 2024
0
4
6
8
10

32. Morningstar Equity Research | 32
Food & EnergyDurablesCore NondurablesHousingOtherTotal
2016201720182019202020212022202320242025202620272028
-4
-2
0
2
4
6
8
10
INFLATION
Durables Deflation Should Continue, While Housing and Other Inflation Subsides in 2024 and 2025
Exhibit Sources: Bureau of Economic Analysis, Morningstar.
Durables deflation is picking up stream, with a 5% annualized price drop in the past
three months; that pace will likely moderate in coming months but remain larger than
normal. Thus, durables prices go from a 0.9% drop in 2023 to a 3.6% drop in 2024 and an
average 2.6% decrease over 2025 to 2028. This is not as dramatic as it might seem at
first glance, given that durables prices fell 1.8% per year over 2015 to 2019.
1
Supply-side
obstacles have largely resolved. Some areas of shortage are even shifting into a glut,
such as in semiconductors. On the heels of durables deflation, core nondurables
inflation is also dropping as supply chain improvement plays out there as well.
Housing inflation remains high, but assuming market rent growth doesn't reaccelerate
(which is likely given continued expansion in housingsupply), it's inevitable that housing
inflation will return to normal.
For all other categories of spending, or "core services excluding housing,"we expect a
gradual deceleration in inflation in 2024 and 2025. Falling wage growth should help.
Also, many of these industries enacted price increases in 2023 to catch-up with the
economywide price level; we see this as a one-time adjustment that largely won't repeat
in coming years.
PCE Inflation Forecast: Key Components (% Growth)
16 %
1 And note that the BEA/BLS adjust for quality improvements, which means that durable goods inflation usually
runs significantly below changes in unit prices.
"Other" = core services
excluding housing

33. Morningstar Equity Research | 33
INFLATION
Further Disinflation in Core Services to Come
Components of Core PCE Services Excluding Housing
Core PCE Services Excluding Housing Inflation, % Growth Year Over Year
Core Services Excluding Housing Is Crucial for Inflation's Normalization
Inflation core services excluding housing was 4.9% in 2022 and 4.3% in 2023, somewhat
lagging the pace reduction seen for core goods (especially durables). This category
accounts for 50% of total personal consumption, hence further reduction in inflation in
this category is crucial for bringing overall inflation down.
The Fed and many economists also assign special significance to this category as
providing perhaps the best signal of inflation's underlying trend (hence the sometimes-
used term "super core"). This has some merits but is not entirely correct. Some
components of core services excluding housing have idiosyncratic drivers which make
them less reflective of the cyclical state of the economy (as we discuss further). Also,
inflation runs a bit higher in this category than the overall economy, averaging 60 basis
points higher than total core inflation over 2005-19. So, it's not necessary to return to 2%
inflation for core services excluding housing to achieve that goal for the overall index.
Core services excluding housing inflation peaked in year over year terms at 5.2% in the
first quarter of 2023. Inflation reduction progress finally manifested in the latter part of
2023, with the inflation rate falling to 3.6% in the fourth quarter. Transportation is one
area where costs came down dramatically, owing chiefly to lower airfares via a pass-
through of lower jet fuel prices. However, by fourth-quarter 2023, we saw more broad-
based reduction in core services excluding housing inflation.
Exhibit Sources: Bureau of Economic Analysis.
Components of Supercore Services PCE%
Healthcare 32.44
Food & Accommodation 14.32
Financial & Insurance 14.84
Transportation 6.56
Recreation 7.79
Communication 3.33
Education 3.65
Professional 2.83
Personal Care 2.08
Social & Religious 3.19
Household & Other 2.99
Nonprofit 5.97
2021 2022 2023
0
4
6
8
10
12
14
Dining & Hotel
Recreation
Transportation
Healthcare
Financial
Nonprofits
Other
Total

34. Morningstar Equity Research | 34
INFLATION
Sensitivity to Labor Costs in Core Services Varies
It's generally said that core services excluding housing is highly driven by labor costs.
This is true for some segments, but not the entire category. Four sectors, namely food
and accommodations, transportation, social and religion, and recreation, have R- squared
values of above 0.75, indicating a strong positive correlation between their sector-
specific inflation rate and the wage growth rate. These add up to weigh 35% of the
overall core services excluding housing measure. However, other segments have a much
weaker relationship with wage growth, reflecting lower labor intensity or idiosyncratic
pricing drivers. To be sure, the wage growth slowdown that we expect (as discussed in
the Labor section of this report) should exert an overall downward pressure on core
services excluding housing inflation, but pricing in segments like finance and insurance,
education, communication, and healthcare may not hew to the trend in wages.
Communication (chiefly cellular and internet services), for example, is a highly capital-
intensive industry. Price changes (particularly for existing customers) tend to be
infrequent and are driven as much by shifts in industry- competitive dynamics as input
costs. Heightened competition in cellular services has helped keep inflation down, but
internet bills rose significantly in 2023 as a delayed catch-up to economywide inflation
seen in 2021 and 2022.
Sector-Specific PCE Inflation and ECI Private Services Wage Growth Correlations
R-Squared
Food &
Accomm.
TransportSocial
&
Religion
RecreationPersonal
Care
House
Mainten.
Communi
cation
Professi
onal
Health
Care
Edu.Financial
&
Insurance
0.00
0.25
0.50
0.75
1.00
0.84
0.820.81
0.80
0.69
0.46
0.43
0.38
0.36
0.12
0.05
Chart guide: "R-Squared" values measures the proportion of the variability in the inflation rates in each
sector that can be explained by wage growth. The closer the value is to 1, the stronger the correlation.
Exhibit Sources: Bureau of Economic Analysis, Bureau of Labor Statistics.

35. Morningstar Equity Research | 35
INFLATION
Further Disinflation in Core Services to Come
Financial Services PCE Inflation and S&P 500 Performance, % Growth Year on Year
Components of Health Care Services PCE Inflation, % Growth Year on Year
Financial services and insurance, with an R- squared value of 0.05, exhibit the weakest
correlation with wage growth out of all 11 sectors. Financial services inflation shows a
strong relationship with asset prices, owing to the way that prices are measured in
several of its components. Thus, the rebound in equity prices in late 2023 and so far in
2024 is helping to buoy that financial services inflation. If equity prices flatten out or fall,
that should ease inflation pressures.
Health care services account for a hefty 32% of core services excluding housing.
Inflation has been conspicuously low in healthcare, which raises the concern that if it
belatedly accelerates it could provide a serious boost to economywide inflation.
Notably, given its high labor share of costs, healthcare inflation shows a weak historical
relationship (R- squared of 0.36) with respect to wage growth. This is probably because
pricing is highly regulated and subject to protracted negotiation between payers and
service providers. The dental and nursing home segments, which may be more
responsive to market conditions than other parts of healthcare, saw much greater
inflation in 2022. In healthcare overall, we've seen cumulative wage growth of 22% from
fourth-quarter 2019 to fourth-quarter 2023, compared with an 11% increase in prices.
Some of this gap is offset by a 5% increase in productivity. Nevertheless, we do expect a
minor uptick in healthcare inflation over the few years as providers compensate for the
gap between prices and wages.
Q4
2019
Q4
2020
Q4
2021
Q4
2022
Q4
2023
0
2
3
4
5
6
7
Total
Outpatient
Dental
Nursing Homes
Hospitals
201520162017201820192020202120222023
–25.00
0.00
25.00
50.00
–2.00
2.00
6.00
10.00
S&P 500
PCE (Financial)
Exhibit Sources: Bureau of Economic Analysis, S&P Dow Jones Indices LLC.

36. Morningstar Equity Research | 36
INFLATION
Housing Market Won't Create Another Inflationary Surge
Rent Inflation Measures, % Cumulative Change Versus January 2020
Median Home Price Versus Trend
Market Rent Inflation Is Already Rapidly Decelerating
The housing component of the main pricesindexes (for example, the CPI shelter
component), responds with a substantial lag with respect to market conditions. This is
by design—the purpose of price indexes is to measure the cost of living, and most
people don't sign a new lease or buy a new house every year. Because of this lag, CPI
shelter inflation is still high compared withprepandemic levels, owing to the
accumulated runup in market rents since 2021.
1
But market rent growth has decelerated
sharply in response to falling housing demand and expanding apartment supply, falling
to only 1.7% year over year as of December 2023. This will cause housing inflation to
inevitably fall. The exact timing is somewhat uncertain, but we expect a gradual decline
in 2024 and 2025.
Deflating Boom Should Cause Housing Prices to Fall
We expect weak home demand to cause home prices to be about flat in nominal terms
over the next several years and thus converge much of the way back to the prepandemic
trend. This will help reinforce restrained rent growth. Lower housing prices will also aid in
returning housing affordability to more reasonable levels. From a cost perspective, lower
home prices should become more palatable for builders as easing supply constraints
reduce the cost of construction input.
Exhibit Sources: Bureau of Labor Statistics, Zillow (top), CoreLogic (top), National Association of Realtors (bottom).
1
Our market rent composite measure includes the Zillow Observed Rent Index and CoreLogic Single- Family Rent Index.
CPI-HousingMarket Rent Composite
2021 2022 20232020
–1
9
14
19
24
30
Home Price ($ thousand)Trend 1990-2019
1990 1995 2000 2005 2010 2015 2020 2025
0
200
300
400

37. US ECONOMIC OUTLOOK | Q1 2024
Monetary, Fiscal, and Financial
Fed to Start Cutting Rates in Mid-2024

38. Morningstar Equity Research | 38
MONETARY, FISCAL, AND FINANCIAL
We Expect the Fed to Shift Back to Easing in 2023 After Victory Over Inflation Looks Clear
Exhibit Sources: Federal Reserve, Morningstar.
We Project a 10- Year Treasury Yield of 2.75% in 2027
The Fed has engineered a massive increase in interest rates to combat high inflation. We
expect the Fed to cut the federal-funds rate aggressively in coming years, falling over
300 basis points by early 2026. We project the 10-year Treasury to fall from 4.3%
currently to 2.75% on average in 2025 (also our long-run expectation). Once the Fed wins
the battle against inflation, its priority will shift to jump- starting economic growth, which
will require much lower interest rates, in our view.
While the path of interest rates over the next couple of years is mainly contingent upon
the cyclical status of the economy, our long-term interest-rate projections are driven by
secular trends. Factors such as aging demographics, slowing productivity growth, and
increasing inequality have acted to push down real interest rates for decades, and these
forces haven't gone away. Regardless of what happens in the next few years, we expect
interest rates to ultimately settle back down at the low levels prevailing prior to the
pandemic. The low-interest-rate regime will resume once the dust settles from the
pandemic economic volatility. Our long-term views and monetary policy framework are
described in further detail in our
US Outlook for Interest Rates, Inflation, and Monetary
Policy.
Interest-Rate Forecasts (Annual Average)
20242025202620272028
Fed Funds Rate5.02%3.29%2.06%1.88%1.88%
10-Year Treasury4.00%3.00%2.75%2.75%2.75%
30-Year Mortgage6.50%5.00%4.50%4.25%4.25%
Federal-Funds Rate10-Year Treasury30-Year Mortgage
201720182019202020212022202320242025202620272028
0
2
3
4
5
6
7

39. Morningstar Equity Research | 39
Futures Market ImpliedMorningstar ForecastHistorical
2022 2023 2024 2025 2026
0
2
3
4
5
6
MONETARY, FISCAL, AND FINANCIAL
Federal-Funds Rate Cuts to Begin in Mid-2024 and Proceed Until 2026
Federal-Funds Rate (%) Expectations (Bottom of Target Range)
Treasury Yields (%)
We Expect the Federal-Funds Rate to Hit 1.75%-2.00% by H1 2026
We expect the first federal-funds rate cut to come in May or June 2024, with five cuts in
2024, bringing the rate down to 4%-4.25% at the end of 2024. We expect a further drop
to 2.25%-2.5% at the end of 2025 and 1.75%-2% (our long-run expectation) by the first
half of 2026.
In the past month or so, markets have backed off expectations for accelerated rate cuts
and have instead converged with the Fed's guidance (the Federal Open Market
Committee projections), last issued in December. But those same Fed projections called
for core PCE inflation of 2.4% year over year in fourth-quarter 2024, whereas we expect
core PCE inflation of just 2.1% in second- quarter 2024. That inflation progress, combined
with weakening economic growth toward mid- to late 2024, should generate more cuts
than the Fed is currently projecting. We project inflation to dip below the Fed's target in
2025 and unemployment to rise slightly above its current projection (4.1%), which should
create continued cutting through the end of 2025.
Treasury yields have rebounded in accordance with higher federal-funds rate
expectations, with the 10-year moving to 4.3% from 3.9% in early January. We now
think the 10- year Treasury yield will average about 4% in 2024, up from 3.5% previously.
This is because we don't think the market will converge with our views on monetary
policy until later in 2024, as well as recent hints that the Fed may prolong quantitative
tightening later than we initially thought.
Exhibit sources: Federal Reserve, Chicago Mercantile Exchange (top).
Fed (FOMC) Projections
2-Yr5-Yr10-Yr
Apr Jul Oct Jan
2023
Apr Jul Oct Jan
2024
Jan
2022
0
2
3
4
5
6

40. Morningstar Equity Research | 40
MONETARY, FISCAL, AND FINANCIAL
Spike in Interest Rates Should Curb Economic Activity, Particularly in Housing
Treasury Yields and Mortgage Rates
Treasury Yields and Corporate Bond Yields
Jump in Mortgage Rates Will Cool Off Housing
Thirty-year mortgage rates stand at 6.9%, down from highs of 7.8% back in November
2023 but still very high. Spreads versus Treasury yields remain elevated compared with
prepandemic levels. The main driver of higher spreads appears to be prepayment risk, as
today's borrowers are extremely likely to refinance when rates eventually fall, and
investors must be compensated for this. Models of the "option-adjusted spread" (which
strip out the prepayment risk) generally indicate an increase of only zero to 50 basis
points compared with prepandemic levels. So, spreads should return to normal as
interest rates fall.
Corporate Yields Are Also Up, Though the Impact Probably Won't Be Large
Rates on corporate bonds are also elevated— about as much as we'd expect, given the
increase in Treasury yields. Spreads on lower-rated issues have widened a bit, but not
drastically (certainly far less than in the 2008 financial crisis). We expect the recovery in
business investment to be modestly affected by higher interest rates. Research shows
that business investment is highly insensitive to interest rates in general. A recent survey
found that just 30% of CFOs are currently planning to reduce capital spending in response to higher interest rates.
Exhibit Sources: Federal Reserve, Freddie Mac (top), ICE BofA (bottom).
10-YR Treasury30-YR Mortgage Rate
200220042006200820102012201420162018202020222000
0
4
6
8
10-YR TreasuryAAA Corp Bond YieldBBB Corp Bond Yield
200020022004200620082010201220142016201820202022
0
4
6
8
10

41. US ECONOMIC OUTLOOK | Q1 2024
Appendix

42. Morningstar Equity Research | 42
Morningstar - US Economics Dashboard
2012 2013 2014 2015 2016 2017 2018 2019 2020 20212022 20232024 E2025 E2026 E2027 E2028 E 2014-192019-28
U.S. Real GDP by Expenditure (% Growth)
Personal Consumption 1.4% 1.7% 2.8% 3.4% 2.5% 2.6% 2.7% 2.0%-2.5%8.4% 2.5%2.2% 2.0%1.6% 2.3%2.6% 2.5% 2.6% 2.4%
Residential Investment13.0%12.7%4.3%10.6%7.1% 4.3%-0.7%-0.9%7.2%10.7%-9.0%-10.6%0.3% 2.1%11.4%8.7% 4.2% 4.0%2.5%
Business Investment 10.6%6.2% 7.0% 5.1%-2.0%4.5% 7.6% 4.1%-7.7%8.1%9.0% 1.1%2.7% 0.4%2.4% 4.4%3.4% 3.8% 2.5%
Government Spending -2.1%-2.4%-0.9%2.0% 2.0% 0.6% 2.0% 3.9% 3.2%-0.3%-0.9%4.0% 1.3%0.5% 1.3%1.0% 1.0% 2.1% 1.2%
Exports 4.0% 3.0% 3.9% 0.3% 0.5% 4.1% 2.9% 0.5%-13.1%6.3%7.0% 2.7%2.5% 3.5%3.3% 3.0%3.0% 1.6%1.9%
Imports 2.4% 1.2% 5.2% 5.2% 1.5% 4.7% 4.0% 1.2%-9.0%14.5%8.6%-1.6%1.5%1.8% 1.8%1.5%1.5% 3.3%2.1%
GDP Growth % 2.3% 2.1% 2.5% 2.9% 1.8% 2.5% 3.0% 2.5%-2.2%5.8% 1.9%2.5% 2.0%1.5% 2.6%3.0%2.6% 2.5%2.2%
Nominal GDP - $ Trillion16.3 16.9 17.6 18.3 18.8 19.6 20.7 21.5 21.3 23.6 25.727.4 28.429.2 30.431.8 33.2 4.1%4.9%
% Growth 4.2% 3.9% 4.3% 3.9% 2.8% 4.3% 5.3% 4.2%-0.9%10.7%9.1% 6.3%3.7% 2.9%4.1% 4.7%4.4%
Inflation (% Growth)
GDP Deflator 1.9% 1.7% 1.7% 0.9% 1.0% 1.8% 2.3% 1.7% 1.3% 4.6%7.0% 3.6%1.6% 1.4%1.5% 1.6%1.7% 1.5%2.8%
PCE 1.9% 1.3% 1.4% 0.2% 1.0% 1.7% 2.0% 1.4% 1.1% 4.2% 6.5%3.7% 2.0%1.6% 1.8%1.9%2.0% 1.3%2.7%
PCE - Core 1.9% 1.5% 1.5% 1.2% 1.6% 1.6% 1.9% 1.6% 1.3% 3.6%5.2% 4.1%2.3% 1.8%2.0% 2.0%2.1% 1.6% 2.7%
Labor Market
Unemployment Rate (%)8.1% 7.4% 6.2% 5.3% 4.9% 4.4% 3.9% 3.7% 8.1% 5.3% 3.6%3.7% 4.0%4.4% 4.2%3.9% 3.5%
Labor Force Participation (%)63.7%63.2%62.9%62.7%62.8%62.9%62.9%63.1%61.7%61.7%62.2%62.7%62.8%62.7%62.7%62.8%62.8%
LFP % - Prime Age 81.4%81.0%80.9%80.9%81.3%81.7%82.1%82.5%81.4%81.6%82.4%82.8%83.1%83.1%83.3%83.5%83.6%
Supply Side (% Growth)
Potential Hours Worked1.0% 0.7% 0.6% 0.9% 0.9% 0.2% 0.7% 1.2% 0.0% 0.2%1.1% 0.8%0.4% 0.5%0.5% 0.5%0.5% 0.8%0.5%
+ Actual Hours/Potential0.9% 0.6% 1.3% 1.2% 0.3% 0.9% 1.1%-0.2%-6.6%4.3% 2.1%0.6% 0.4%-0.3%0.6%0.9%0.8% 0.7%0.3%
= Hours Worked 1.9% 1.3% 2.0% 2.1% 1.2% 1.2% 1.9% 0.9%-6.6%4.5%3.1% 1.4%0.8% 0.2%1.1% 1.4%1.4% 1.5% 0.8%
Labor Productivity 0.3% 0.8% 0.5% 0.8% 0.6% 1.3% 1.0% 1.5% 4.7% 1.3%-1.2%1.1% 1.3%1.3% 1.5%1.6% 1.2% 1.1% 1.4%
Output Gap (% Potent. GDP)-5.4%-5.2%-4.6%-3.8%-4.0%-3.1%-2.1%-2.0%-5.4%-1.4%-1.9%-1.6%-1.5%-1.9%-1.3%-0.5%0.0%
Other
Govt Budget Balance (% GDP)-9.3%-5.9%-5.2%-4.6%-5.4%-4.4%-6.1%-6.7%-14.8%-11.5%-4.0%-6.4%-6.4%-7.0%-6.5%-6.1%-5.7%
Net Exports (% GDP) -3.4%-2.8%-2.9%-2.9%-2.7%-2.8%-2.9%-2.7%-2.9%-3.6%-3.8%-2.9%-3.1%-3.0%-3.1%-3.0%-2.9%
Market (Year Avg)
Fed Funds Rate 0.14%0.11%0.09%0.13%0.40%1.00%1.83%2.16%0.38%0.08%1.68%5.02%5.02%3.29%2.06%1.88%1.88%
10-Year Treasury Yield1.80%2.35%2.54%2.14%1.84%2.33%2.91%2.14%0.89%1.44%2.95%3.96%4.00%3.00%2.75%2.75%2.75%
CAGR:

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