The Soft Landing Gets More Comfortable

Jul 26, 2023

Construction and infrastructure are showing stronger-than-expected growth, improving GDP forecasts for the second half of the year into 2024.

Ellen Zentner

Key Takeaways

  • The “soft landing” that Morgan Stanley has predicted for the U.S. economy may be even gentler than expected.
  • We have increased our GDP forecast based on strong performance in construction and infrastructure.
  • We believe that the federal funds rate peaks at 5.375% this year, with the first cut coming in March 2024.

The U.S. economy may prove more resilient in the second half of 2023 than many forecasters had expected. Morgan Stanley Research has consistently called for a soft landing, marked by a moderate economic slowdown rather than a recession, but new data indicate that the touchdown may be even gentler than expected. Even better, a number of factors should keep new areas of growth from contributing to continued inflation. Here’s what investors should understand about the economic outlook over the coming months.


A More Positive Picture for GDP

In the first quarter of 2023, real gross domestic product (GDP) grew at an annualized pace of 2.0%, and we are currently tracking real GDP growth for the second quarter at 1.8%. Based on recent data, we are now raising our forecast for real GDP growth by 0.9 percentage points in 2023 to 1.3% for fourth quarter over fourth quarter and 1.4% for 2024.


What is driving the change? First, investment in non-residential structures is the largest contributor, contributing 0.3 percentage points to the upward revision to GDP growth. In particular, spending on manufacturing construction in the technology industry is up 235% over the 12 months ending in May, with other manufacturing spending up 7%.


Second, state and local investment is also stronger than expected. The November 2021 Infrastructure Investment and Jobs Act has increased public investment in infrastructure, helping to mitigate more than a decade of persistent underinvestment.


These two factors bolster our longstanding rationale for a soft landing, based on the following:


Shrinking consumption and gradually decelerating inflation: A rising savings rate is cutting into consumer spending, bringing down the prices of goods and services.


Slowing job growth: Although unemployment remains low, job gains are likely to slow down. We continue to forecast an unemployment rate of 4.0% in the fourth quarter of 2023 and 4.4% for the end of 2024.


Housing recovery: After eight straight quarters of decline, the housing correction has hit bottom. For the second quarter of 2023, residential investment is turning upward at an annualized pace of 0.3%.


Avoiding Additional Inflation

Our forecast for GDP growth shows that the economy is not declining enough for the Federal Reserve to start cutting rates. However, core inflation and job creation are moving in the right direction. The previously underestimated growth in construction and infrastructure is unlikely to push inflation higher:


  • With construction costs coming down, investment in non-residential structures is growing substantially, while price growth has been half the pace of the prior four quarters.

  • Construction is labor-intensive, and although wages may increase with demand, the labor supply overall is increasing.


  • Infrastructure investment can meaningfully lift productivity and potential GDP growth. Higher productivity lowers companies' labor costs, reducing pressure on prices.


All of these factors strengthen the case for a soft landing for the U.S. economy in 2023. As a result, we continue to believe that the federal funds rate has peaked this year at 5.375% (the midpoint of the 5.25%-5.5% range announced on July 26), with the first cut coming in March 2024. 

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