Mark Vitner

The primary season is now underway, setting the stage for another critical presidential election year that captures the attention of business leaders, households, and policymakers alike. Traditionally, presidential election years are perceived as pivotal moments for the economy. Upon closer examination, however, the relationship between economic growth and election cycles is more nuanced.

Real GDP, our best measure of aggregate economic growth, has risen a modest increase of just 0.1 percentage points faster in presidential election years compared to its rolling 8-year average dating back to 1960. This marginal difference challenges the commonly held belief that election years are significantly more prosperous for the economy, as incumbents pull out all the stops via tax cuts, increased spending, or promised handouts.

Rather than bolstering economic performance, incumbent presidents and their political parties are likely to be at the mercy of the economy’s most recent performance. Over the past 16 presidential elections, incumbent parties have typically struggled when real GDP grew less than its trailing 8-year average leading up to the election, resulting in losses in 7 out of 8 those instances. Conversely, when election-year economic growth outpaces the previous 8 years, the incumbent party has won 6 out of 8 times. This straightforward measure has been correct 81.25% of the time.

As the presidential election year progresses, the relationship between economic performance and political outcomes will take center stage. The delicate balance between economic growth, inflation, and key economic benchmarks such as the Misery Index, Real After-Tax Income Per Person, and Consumer Confidence will shape the election season’s narrative, influencing voters, business decisions, and policy choices. This issue of the CAVU Compass will briefly review these key concepts in the context of our latest economic forecast.

Real GDP is the most comprehensive measure of aggregate economic well-being. It quantifies the volume of goods and services produced by measuring aggregate purchases of finished goods and services on a net basis, encompassing consumers, businesses, governments, and international purchasers. Real GDP has risen 2.9% over the past year, primarily due to surprisingly strong growth in the third quarter of last year. The first look at Q4 GDP comes on January 25 and is expected to show growth decelerated to a 2.1% pace. We anticipate further
moderation this year, with real GDP rising at a 1.6% pace on a fourth-quarter to fourth-quarter basis.

The current consensus is the U.S. economy will narrowly avoid a recession this year. The latest Wall Street Journal Economic Forecast Survey has real GDP growing just 1% in 2024. Job growth is expected to slow further and the unemployment rate edge higher from its current 3.7% to 4.3%. Inflation is expected to slow to 2.3% by yearend. The Survey calls for the Fed to cut interest rates three or four times beginning sometime in the first half of the year. Thirty-nine percent of economists expect the economy to fall into recession in 2024, down from 48% in October and 61% one year ago.

The soft landing scenario envisioned by the majority of economists will likely have an impact on the presidential election. Voters tend to vote with their wallets and incumbents have typically run into trouble when the economy is struggling. The consensus calls for real GDP to rise just 1% during the year leading up to the election. Such a result would yield growth 1.5 percentage points slower than real GDP growth has averaged over the past 8 years. That gap is significantly larger than the 0.9 percentage point gap averaged in the 9 elections since 1960 where incumbent party candidates lost and is one of the largest deviations, excluding recession years.

Our own forecast is a little more optimistic than the Wall Street Journal consensus even though we continue to look for the economy to be just a touch softer than a traditional soft landing. We look for real GDP to rise 1.7 percent from the fourth quarter of 2023 to the fourth quarter of 2024 and look for nonfarm employment growth to decelerate to a pace that produces a net gain of 110,000 jobs per month. Such an outcome would produce a slightly smaller gap (0.8 percentage points weaker) between economic growth in the year leading up to the presidential election than has been averaged in the 9 elections when the incumbent party. By contrast, winning incumbents have on average enjoyed economic growth that was 1.2 percentage points stronger in the year leading up to the presidential election than in the preceding eight years.

Comparing economic growth to its recent average is a bit more complicated today due to the extreme volatility in most measures of economic growth surrounding the pandemic, as well as the burst in economic activity that followed three successive rounds of direct stimulus payments to households and businesses. The economy has a great deal of stimulus in the pipeline, including the Inflation Reduction Act, the Bipartisan Infrastructure Act, the CHIPS and Science Act, and the Rescue and Recovery Act.

Fiscal policy was often used to boost growth ahead of presidential elections. The onslaught of stimulus following the pandemic has bloated the federal budget deficit, however, and will likely make it more difficult to provide additional fiscal stimulus this year. The budget deficit is expected to decline slightly this year, but slower economic growth will likely reduce tax receipts, while increased defense and security needs will pull spending higher. We look for the federal budget deficit to remain around its current 1.8 trillion this fiscal year.

While the persistence of large budget deficits and periodic showdowns over continuing to fund the deficit generate a lot of headlines, the budget deficit itself has historically not been a major driver of election outcomes. The persistence of large budget deficits is not expected to have much of a direct influence on the 2024 election, although it will make it more difficult for policymakers to prime the pump before the election and might also exert some upward pressure on long-term interest rates.

One of the most popular measures of economic well-being during election years is the Misery Index. The Misery Index, created by economist Arthur Okun, is a simple measure that combines the inflation rate and unemployment rate to gauge the overall economic well-being of a country. Okun, who was an economic advisor to President Kennedy, introduced the concept in the 1960s to provide a straightforward assessment of the economic conditions affecting the average citizen. The index is calculated by adding the inflation rate, calculated from the 12-month change in the CPI, to the unemployment rate, providing a quick synopsis of economic conditions that is easy to compare over time.

The trend in the Misery Index has historically been more predictive than the absolute level. The index improved during the Kennedy Administration, which came into office during a time of stagflation, falling from 7.5% when Kennedy was elected in 1960 to 6.1%. Nearly all the improvement came from a reduction in the unemployment rate, which fell from 6.1% to 4.8%. The inflation rate fell from 1.4% to 1.3% during this period.

The Misery Index performance during the Kennedy Administration is instructive on how the inflation-unemployment tradeoff plays out in Democrat and Republican administrations. Successful democratic administrations have mostly focused on reducing unemployment, while republican administrations have seen more success in reducing inflation. The index rose during the Johnson Administration, climbing from 6.1% when Lyndon Johnson was elected to 8.1% in November 1960, when his successor Hubert Humphrey lost to Richard Nixon. All of the increase came from higher inflation. The unemployment rate actually declined.

The Misery Index gained prominence in the 1970s when stagflation emerged as a major economic problem. However, the index is far from perfect in predicting a presidential winner. Nixon secured a historic landslide re-election in 1972, despite a 0.9 percentage point rise in the Misery Index, solely attributable to a higher unemployment rate. Inflation slightly decreased during Nixon’s first term.

Gerald Ford assumed the presidency after the Watergate Scandal led to Nixon’s resignation in August 1974. Ford inherited an economy grappling with both rising inflation and increasing unemployment.

Ford placed significant emphasis on combating inflation, introducing a program called Whip Inflation Now (WIN). Although inflation did decrease during his short presidency, the Misery Index still concluded his term 3.7 percentage points higher than when Nixon was re-elected in 1972 and 4.5 points higher than when Nixon was initially elected in 1968.

Jimmy Carter was quick to point out how much the Misery Index had risen in his successful bid for the White House in 1976. Unfortunately, containing inflation proved exceedingly difficult during Carter’s presidency, which saw the inflation rate rise by 7.8 percentage points to 12.6% in November 1980. The unemployment rate actually fell by 0.3 percentage points during Carter’s term but remained high at 7.5% on Election Day 1980. Reagan won the presidency in a historic landslide and famously reminded voters to ask themselves if they were better off now than they were four years ago? The Misery Index improved significantly under Reagan, mostly due to sharply lower inflation, and he was handily re-elected in 1984.

The Misery Index improved further during Reagan’s second term, paving the way for George Bush to win the presidency in 1988. However, the Misery worsened under his presidency, being 3 percentage points higher when he lost his re-election bid to Bill Clinton in 1992, with the entire increase attributed to a higher unemployment rate. The Misery Index improved during Clinton’s first term, leading to his easy re-election. The Index has been less instructive in every presidential election since, however, as a lower Misery Index failed to provide enough of a boost to secure victory for Al Gore against George W. Bush. Additionally, slight improvements or worsening in the Misery Index have incorrectly predicted every election since.

One reason why the Misery Index has lost some of its luster in recent elections is that inflation was consistently low from the mid-1990s to the pandemic, shifting more attention to the unemployment rate and
other issues. Of course, inflation spiked following the pandemic, and while it has been moderating recently, prices for groceries, housing, entertainment, and travel remain well above pre-pandemic levels. This may explain why such a small share of consumers currently rank current economic conditions as good.

Another reliable measure of economic well-being that has correctly predicted the outcome of 10 of the past 16 presidential elections since 1960 is real after-tax income per person, which is also sometimes referred to as take-home pay minus inflation. The critical level in real per capita disposable income growth is 1.5% in the year preceding the presidential election. When take-home pay per person, minus inflation, rises by 1.5% or more in the year leading up to the presidential election, the incumbent or the person representing the party currently occupying the White House is almost always reelected.

Real after-tax disposable income is better than simply observing the change in the Misery Index and correctly projected Hillary Clinton would lose to Donald Trump in 2016. This measure has had some notable exceptions. Despite a 3.5% growth in real per capita disposable income in the year leading up to the 1968 election, Humphrey lost to Nixon, indicating economic factors alone did not secure victory. Humphrey’s defeat was likely fueled by the nation’s growing frustration with the Vietnam War, underscoring the influence of broader social and political issues on electoral outcomes.

Ford also experienced strong income gains in the year leading up to his 1976 reelection battle, with real take-home pay per capita rising by a solid 2.3%. Despite this economic boost, Ford lost, as simmering anger over the Watergate scandal overwhelmed the modest improvement in the economy. Similarly, Gore’s loss to George W. Bush was likely influenced by some residual anger over the Monica Lewinsky affair and the subsequent impeachment of Bill Clinton. More recently, Trump’s narrow victory over Hillary Clinton in 2016 was likely fueled by lingering angst about the frustratingly slow recovery from the Global Financial Crisis.

The 2020 election miss is beyond the scope of this report. While real take-home pay per person surged by 4.3% in the year preceding the election, the year was marred by the COVID-19 Pandemic and massive relief efforts to contain the resulting economic damage. The income series has been unusually volatile since the pandemic due to repeated stimulus programs. The 3.5% increase over the past year would appear to be good news for Joe Biden, but growth has slowed more recently, with real take-home pay falling at a 0.3% annual rate in the most recent quarter. With economic growth slowing, we expect real take-home pay to rise very close to the 1.5% threshold needed for incumbents to be reelected.

The three benchmarks we introduced suggest this election cycle is likely to be tough for incumbents. Real GDP is expected to grow 0.8 percentage points slower this year than its average for the past 8 years, which has typically signaled a loss for the incumbent party occupying the White House. On the plus side, the Misery Index is projected to be 1.1 percentage points lower than when Biden was elected, with all of the improvement coming from lower unemployment. While inflation is expected to moderate, the CPI should still rise more than twice as much in 2024 as it did in the year preceding the 2020 election, and prices for key necessities are much higher than they were four years ago. Along those lines, real after-tax income per capita is likely to rise by 1.5% at best during the year leading up to the 2024 election. Based on recent experience, incumbents would lose, meaning the leadership of the White House, Senate, and House of Representatives would all likely change parties.

Predicting election outcomes is even more perilous than predicting the economy. A host of non-economic issues could easily overwhelm concerns about the economy, including global affairs, social issues, and the personal attributes of the candidates. The outcome of the election will have significant consequences on everything from geopolitics, global trade, the composition of the Fed and various regulatory agencies, and fiscal policy.

Our economic outlook is slightly more upbeat than it was a month ago. Real GDP in the fourth quarter now looks like it grew at a 2.1% annual rate, thanks to continued strong consumer spending and the continued buildout of a multitude of industrial projects. State and local government spending also looks to have risen solidly, given the continued growth in state and local government payrolls. Inventories are expected to grow more slowly and be a drag on Q4 growth.

We have also raised our 2024 forecast and now see growth just a touch softer than a soft landing, with real GDP expected to rise by 1.7%. Nonfarm employment is anticipated to decelerate, with employers adding only 110,000 jobs per month. The unemployment rate is predicted to increase to 4.1% by the end of the year. We maintain concern regarding traditional warning signals, such as the inverted yield curve and a 21-month decline in the Leading Economic Index. While the risk of a recession remains elevated, the more likely scenario is a continuation of the rolling recessions that have been ongoing for the past year.

Inflation is expected to continue to moderate, allowing the Fed to begin to cut interest rates this spring. Our forecast includes three quarter-point cuts in the federal funds rate, with the first in May or June. Another cut is expected in September and then the Fed will likely hold rates steady through the November election, after which
a final cut is likely. Despite the bond market factoring in five or six quarter-point cuts this year, we do not foresee the economy weakening or inflation moderating enough to justify such extensive cuts. The 10-year Treasury is expected to rise back to 4.20%, which will keep mortgage rates in the 6.50% range through the end of the year.

The case for a soft landing was bolstered this past month, which saw the majority of economic data continue to come in on the soft side, while inflation continued to moderate. Fears of recession have subsided, and a majority of economists now see a soft landing in 2024, with real GDP growth slowing below its long-term potential and inflation continuing to moderate towards the Fed’s 2% inflation target. We continue to expect the economy to slow to a pace just a touch softer than a traditional soft landing and expect to see real GDP decline slightly during the first half of 2024. Nonfarm employment is expected to continue to edge higher, however, which we believe will prevent the NBER from labeling this slowdown as an outright recession.

Interpreting the ups and downs of economic activity is unusually difficult today because of the enormous swings in economic activity brought about by the pandemic and the policy response to it. Direct and indirect stimulus to households, businesses, and state and local governments helped fuel a massive economic recovery when the economy reopened following the pandemic. The resurgence led to widespread shortages, which helped drive inflation sharply higher and eventually caused the Fed to aggressively hike interest rates. This past year has seen conditions begin to normalize, as higher interest rates and tightening credit conditions have slowed capital spending, home sales, and consumer spending for big-ticket items. Spending remained strong enough for real GDP to grow 3.0% this past year, a point driven home by the third quarter’s blistering 5.2% annual rate growth.

The abrupt swings in economic activity and inflation led to unusually large moves in some of the most hallowed economic indicators. The yield curve, which captures the difference between short-term and long-term interest rates, inverted 17 months ago and has remained inverted. Inverted yield curves have preceded every recession in the modern era, with a typical lag of between 12 and 18 months. In addition, the Leading Economic Indicators index has declined for nineteen consecutive months and is currently 7.6% below its year ago level. The LEI has never fallen this far or for this long without the economy falling into recession.

Given the plunge in the LEI, it is surprising that talk of recession has subsided as much as it has. One reason the slide in the LEI may not be as telling as it has been the past is that several components of the LEI have been distorted by the huge swings in economic activity surrounding the pandemic and its aftermath. The surge in consumer purchases of big-ticket items including furniture, appliances and home electronics led to a surge in factory orders for consumer goods and output, which lifted the LEI as the economy emerged from the pandemic. Goods purchases weakened this past year, however, as spending shifted toward services and experiences. Services and experiences spending does not directly feed into the LEI, so this summer’s strength did not stem the slide in this key indicator.

History suggests it would be a mistake to dismiss the risks of recession associated with the slide in the LEI and the inverted yield curve. Afterall, banks borrow short-term and lend long-term, which means an inverted yield curve, with short-term rates higher than long-term rates, means bank lending is less profitable. This means banks will lend more selectively and take fewer risks, which slows credit growth and economic growth more broadly.

The primary reason so many economists have backed off their calls for a recession is job growth remains remarkably resilient. Employers added 199,000 jobs in November, continuing a string of solid, albeit gradually decelerating job gains. November’s job growth was bolstered by the return of 38,000 workers on strike in the auto sector and motion picture business. As in recent months, Health care (+76,800), government (+49,000), and Leisure and Hospitality (+40,000) accounted for the bulk of job gains. Employment declined in a few notable sectors including Retailing (-38,400), Employment Services (-24,600), Nondurable Goods Manufacturing (-8,000) and Transportation & Warehousing (-5,000). Even with these losses, however, the share of industries adding jobs in November edged higher to 54.6%. Job gains were more widespread a year ago, however, when the private payroll diffusion index was a robust 63.4%.

While nonfarm employment growth is clearly decelerating, job growth remains strong enough to keep the unemployment rate at the lower end of the range considered to be ‘full employment.’ The number of employed in the household survey surged by 747,000 in November, significantly outstripping a 532,000-person rise in the labor force. The unemployment fell 0.2 percentage points to 3.7%.

We expect hiring to decelerated further in coming months and suspect nonfarm employment is currently overstated. The BLS annual revision to nonfarm payrolls that will be released in early February will reduce payroll growth from April 2022 to April 2023 by 306,000 jobs, or about 0.2%. Job growth has likely decelerated further since then, however. Private sector payroll growth has been revised lower from its initially reported gain every month this year, including a -14,000 job revision to the October data. Even with the downward revision, private employers have added an average of 145,000 jobs a month over the past 3 months. That should provide enough cushion to keep payroll growth in positive territory, even if GDP growth dips slightly into negative territory early next year.

Question 2: Will inflation decelerate enough for the Federal Reserve to cut the federal funds rate? We believe it will. The overall CPI topped out at 9.1% in June 2022 and has fallen back to just 3.1% in November. The bulk of the improvement in the CPI has come from two areas: falling energy prices and a reversal in the spike in used car prices. Price pressures are moderating more broadly. We follow the Trimmed-Mean CPI, produced by the Federal Reserve Bank of Cleveland, and provides a broader picture of inflation than the widely followed core CPI but still excludes outliers. The Trimmed-Mean CPI has moderated along with the core CPI, falling from a recent peak of 7.3% in September 2022 to 4.0% in November of this year.

We expect inflation to continue to decelerate in 2024 but do not look for the core CPI to fall back to the Fed’s 2% target until the latter part of 2025 or later. Even so, the Fed should still be able to reduce the federal funds rate this coming year, however. The real federal funds rate, as measured as the difference between the mid-point of the federal funds rate target (5.50%) and trailing 12-month change in the core CPI (4.0%), is currently 150 basis points. We expect the year-to-year change in the core CPI to decelerate to 3.2% by the end of this year, which should allow the Fed to cut the federal funds rate by a quarter point three times in 2024. We feel the earliest the Fed would cut would be at the June FOMC meeting, followed by another cut in September and then another following the November election.

Question 3: Have long-term interest rates peaked for this cycle? Long-term interest rates have peaked for the cycle but may overshot to the downside in the rally that followed the better than expected inflation data for October and more recent acknowledgement by the Fed that they would likely cut interest rates in 2024. While we expect inflation to continue to decelerate, the improvement this coming year will be less dramatic than this past year. Prices for core services, which are primarily driven by wages, remain more problematic and are likely to improve only modestly this year. Inflation will still improve enough for the Fed to cut interest rates, just as not as early as the financial markets are now pricing in and not as aggressively. We look for a maximum of three quarter point cuts in 2024 and four quarter point cuts in 2025. Bond yields will retrace part of their recent declines, rising back to 4.50% and remain slightly above the 4.26% the 10-Year Treasury has averaged for the past 33 years.

Question 4: Will the drop in long-term interest rates provide a significant boost to home sales. Partially Yes. Home sales nearly ground to a halt when mortgage rates briefly spiked up to 8% and there was also a slew of cancelations to previously signed purchase contracts. Now that mortgage rates have fallen back to 7.20%, buyers will return to the market. New home sales and new home construction will certainly get a boost, but with job growth slowing even fewer existing homeowners are likely to put their homes on the market, which will further limit resales.

We have a cautious housing forecast for the coming year. Slower job and income growth will weigh on consumer confidence and slow overall home sales. We look for existing home sales to fall 6% from their current level by the middle of 2024. New home construction will continue to take market share from the existing home market, with the large national home builders faring the best. Home builders are routinely using their incentive budgets to buy down mortgage rates, which is particularly appealing to first-time buyers. That said we, are still looking for new home sales to decline modestly (-4.3%) during the first half of 2024, reflecting slower overall job growth.

Question 5: Will Commercial Real Estate deteriorate to the point that it leads to a significant credit crunch? The credit crunch already underway will linger and intensify but credit conditions will not tighten so much that they stifle overall economic growth. The office market presents the greatest challenge, as office workers have been reluctant to return to the office full-time. Office vacancy rates has climbed steadily this past year as businesses have consolidated their space needs. True vacancy, which would account for leased but vacant space, may be as much as ten percentage points higher than the current 19.2%. We see that as the upper bound, however, as some of this space will be repurposed to other uses.

Attention is now swinging to the apartment and industrial markets, both of which have seen a tremendous amount of new construction in recent years and have a significant pipeline of projects under construction. Lending for new apartment projects tightened this past year and we expect multi-family starts to decline 50% from their 2023 levels. Demand for apartments remains fairly strong and vacancy rates appear manageable at around 5%. Unfortunately, there are close to one million apartments under construction and demand for apartments will slow as job growth decelerates further in 2024.

The warehouse and industrial market has been one of the top-performing real estate sectors, benefiting from a surge in ecommerce and the recent push for near-shoring. Demand cooled this past year as goods purchases slowed, but vacancy rates remain low at just 4.6%. We expect new construction to moderate next year amidst tighter credit and generally slower economic growth.

Economic growth has slowed from its torrid third quarter pace, which saw real GDP grow at a 5.2% annual rate. The widely followed Atlanta Fed GDPNow nowcast, which was one of the first to call for a spike in growth during the third quarter, pegs current growth at just 1.2%. Our forecast is a little higher than that at 1.6%, but much of the growth occurred at the start of quarter and we expect activity to slow toward the end of the quarter. Holiday retail sales got off to a soft start and we expect spending to rise at the lower end of the 3% to 4% range projected by the National Retail Federation. Sluggish real income growth is back holding spending, although falling gasoline prices are providing a short-term boost to consumer sentiment and buying power.

Our forecast for the first half of 2024 is likely toward the lower end of consensus. We expect to see a preponderance of disappointing economic reports early next year and look for real GDP to decline at a 1.7% annual rate in the first quarter, followed by a 0.6% drop in Q2. Such a decline would be similar to the drop seen at the start of 2022, which the NBER did not label as a recession. This downturn is likely to be more broad based, but as we noted earlier, we do not expect nonfarm payrolls to post an outright decline. If payrolls do decline, the odds a recession increase exponentially.

As for interest rates, we feel the bond market has gotten ahead of the Fed. Policymakers will take their time moving from a tightening bias to a neutral bias and finally to an easing bias, which will push the first rate cut out into June. Bond yields will need to rise from current levels to incorporate a slower pace of rate cuts and higher end point, which we currently see as somewhere around 3.50%. An outright recession would speed this process up and result in a lower end point for the federal funds rate, likely closer to 2%.