California’s slower-growing economy continues to outpace the weak growth of the U.S. economy.
In its fourth and final economic forecast of 2023, the UCLA Anderson Forecast reported that the threat of imminent recession has faded. This development results from expansionary fiscal policy, new national industrial policy and a consumer that continues to spend, despite overall economic uncertainty. However, growth in the U.S. economy will be tempered as interest rates remain high and inflation rates only slowly recede.
In California, employment growth slowed at a rate higher than expected. Though the state’s economy will continue to grow more quickly than the nation’s, the difference will, for the first time in several years, be quite small. This is in part because of slower U.S. economic growth, a slowdown in investment and slower logistics sector growth.
The National Forecast
A brief history lesson enables better understanding of the current national economic outlook: From January 1994 through March 1995, the U.S. economy was buffeted by a string of seemingly negative news, including rising interest rates and a sinking Treasury yield curve. The rising interest rates contributed to the bankruptcy of Orange County, and a 1995 government shutdown loomed.
All this negativity led some economists to forecast a recession, despite the fact that the data underlying the headlines indicated otherwise. Ultimately, the U.S. economy grew 4% in 1994, 2.7% in 1995 and 3.8% in 1996. Although the 1995 economy was very different from today, there are similar headlines.
The 2023 debt ceiling and government shutdown crises turned out to be short-lived, as did labor strife in the auto industry. Retail sales remained strong through September and weaker in October, related to the temporary UAW strike. The backlog of durable goods orders continues to grow, and factory construction is soaring. Though core inflation is coming down slowly, the UCLA Anderson Forecast does not expect the Fed to increase the effective federal funds rate for the balance of the year. The Fed is expected to hold the rate where it currently sits until sufficient weakness in the economy (which Anderson economists forecast for mid-to-late 2024) results in some moderate rate reductions.
Circumstances in 2023 are different, but the current forecast shows a somewhat similar pattern to 1994 through 1996, when negative news overshadowed positive signs in the underlying economic data. The oft-predicted but never seen “recession next quarter” has now faded in the face of expansionary fiscal policy, new national industrial policy and a consumer who is happy to continue spending. The impact of higher interest rates will be felt in restraining growth in 2024. Inflation is slowly working its way back to the neighborhood of 2.8% per year, primarily because of residential rents, automobile repair and new health insurance premiums.
Nevertheless, the Forecast expects Fed policy to take a neutral stance in the slow-growth 2024 economy. Economic growth is expected to rebound to trend rates by the end of 2025.
Nevertheless, there are risks to the forecast. A protracted government shutdown was averted until 2024, but the possibility still exists. In addition, geopolitical events might upset the current growth pattern. On the more distant horizon, uncertainty about the election in November might result in significantly weaker business investment and consumer spending. These risks are substantial and bear watching, as they could well drive the economy off its current growth path.
The December 2023 UCLA Anderson Forecast for the U.S. is similar to the forecast presented in early October. In September the forecast expected GDP growth in the third quarter of 2023 to be reported at 2.3%, and it came in at an astonishing 4.8%. That was owing in part to inventory replacement following a weak inventory accumulation the previous quarter. Less inventory adjustment is now expected in the current quarter, so the forecast is slightly weaker than three months ago and is now at 1.7%. The balance of the forecast is much the same as the September forecast, featuring a weaker 2024 with three quarters of 1% growth which then accelerates back to 2.5% trend growth by the end of the forecast horizon in 2025. The weaker, undertrend 2024 growth reflects the impact of higher interest rates on consumption, housing and business investment.
The California Forecast
During the early part of this year, uncertainty about California’s 2023 economic outlook was elevated because of the uncertainty in national economic policy. Even though recession worries have faded, increased military activity abroad and a sense of greater geopolitical risk has kept uncertainty about the future high.
This uncertainty factor, combined with a slowed U.S. economy in 2024, suggests a slower-growing California economy. There is some indication in the employment numbers that the fourth quarter of 2023 and the early quarters of 2024 will see small but positive growth. However, the data signals are mixed.
California’s labor force has declined of late, and the unemployment rate has been inching up. While there are still tailwinds in the data, they have moved from relatively strong to a very mild breeze. As such, there is less confidence in California outperforming the U.S. in 2024 than there was three months ago.
A sector-by-sector analysis results in a forecast for the California economy to, once again, grow faster than the U.S., but not by much.
The unemployment rate for the fourth quarter of 2023 is expected to average 4.7%, and the average for 2024 and 2025 is expected to be 4.5% and 3.8%, respectively. The forecast for 2024 and 2025 is for total employment growth rates to be 0.3% and 0.9%. Non-farm payroll jobs are expected to grow at a 1.8% and 1.7% rate during the same two years. Real personal income is forecast to grow by 1.7% in 2024 and 2.7% in 2025.
In spite of the higher interest rates, the continued demand for a limited housing stock, coupled with state policies that induce new homebuilding, should result in the beginning of a recovery this year followed by solid growth in new home production thereafter. The current expectation is for 127,000 new units to be permitted in 2024 and permitted new units to grow to 155,000 in 2025. Needless to say, this level of home building means that the prospect for the private sector building out of the housing affordability problem over the next three years is nil.
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