Viewpoint
July 26, 2024 | 15:35
July 26, 2024
Economics
Economics
Economics
Economics
Economics
Economics
Reading July’s Economic Tea Leaves |
| As the FOMC huddles in Washington, D.C. next week to decide “should they” or “shouldn’t they”, some analysts are calling on the Fed to cut rates. But for a “data dependent” Fed, does the data really support such a rush to slash rates in July? We believe most FOMC voters will think not. While the economic tea leaves have been pointing to softening demand and moderating price pressures for several months now, there was no smoking gun in this morning’s personal income and spending report for June or in the Q2 GDP report to force the Fed from the sidelines. |
| Second quarter GDP accelerated to an above-potential rate of 2.8% a.r. from 1.4% in Q1. A solid bounceback in real consumer spending growth to 2.3% was a big driver. Durable goods spending jumped 4.7% in the second quarter, more than offsetting the first quarter decline, while services spending held at a firm 2.2%, and nondurable spending rebounded to 1.4% (Chart 1). Combined with a surge in government spending (it is an election year after all), and double-digit annualized growth in business equipment spending, final sales to domestic purchasers firmed to 2.7% from 2.4% in the first quarter. Nondefense capital goods orders for June increased 1.0%, suggesting the run of good equipment spending may not be completely over. Even initial jobless claims dropped by 10k last week and remain at a tame 235k. The economy appears to have performed at (or somewhat above) potential growth in the first half of 2024, making it difficult to ascertain if consumer inflation is currently on a sustainable path to 2.0%. We believe it is, but others may not be as convinced. Core PCE inflation eased to 2.9% annualized in the second quarter from 3.7% in the first quarter, a welcome cooling, but it is still some distance away from the Fed’s target. So, looking at the totality of the growth, labor market, and inflation data right now through the Fed’s own lens, it would be difficult to sanction a summer rate cut. Another reason to hold off on July: once the Fed starts cutting, there will be pressure to keep doing so at every meeting. Already, the fed funds futures market is placing a fairly high probability of three quarter-point rate cuts this year and perhaps a fourth by the end of January. Premature easing could be just as dangerous as waiting too long. |
However, a month and a half from now, the case for cutting should be a lot stronger. Year-over-year growth in real consumer spending has been incredibly stable over the past six quarters, averaging around 2.3%. But, real disposable income growth has been steadily eroding in the past four quarters to just 0.9% y/y in Q2 (Chart 2). That means more consumers need to dip into their savings to maintain their real spending gains. The July Beige Book noted price-conscious consumers are scaling back and trading down on purchases in nearly all twelve Federal Reserve districts. If we go through a more volatile period for equity prices, or the labor market comes under more layoff pressure, it won’t take much to throw consumer confidence and spending growth off-balance. Labor market and earnings conditions are gradually ripening for a second-half slowdown in consumer spending that should further cool inflationary pressures. But, none of the early indications are yet definitive or urgent enough, in our view, to prompt the FOMC to move off the monetary policy sidelines. This week’s data likely bought FOMC members another month to work on their golf game and tans before rolling up their sleeves and getting to work in September. |
Fed Policy Preview: Summer Clues to Autumnal Rate Cuts |
| The FOMC meets on July 31, with no policy moves expected. However, market participants will be combing the policy statement along with Chair Powell’s presser preamble and subsequent answers to questions for clues to an autumn-heralding move next meeting along with seasonal sequels. Currently, the market is completely pricing in a quarter-point rate cut on September 18 followed by at least another move by December 18. (There are about 66 bps of total easing priced in by year-end, pointing to more than 60% odds of a third move.) We’re in the two-cut camp, too. The market’s conviction in a September rate cut start has held firm, even amid stronger-than-expected data (such as this week’s 2.8% print for annualized real GDP growth in Q2). For example, although getting fully priced in this week, September’s rate cut odds have been at least 80% for the past 2½ weeks. Market expectations are steady as participants take a cue from the Fed’s evolving risk management approach that is placing more policy weight on labor market outcomes (alongside the inflation readings). At the start of this year, the FOMC began judging that “the risks to achieving its employment and inflation goals are moving into better balance”. On May 1, this phrase was tweaked to say that the risks “have moved toward better balance over the past year”. Then, in July 9-10 congressional testimony, Chair Powell hinted that the risks had moved even further toward better balance (if they weren’t now already balanced). Powell said: “We know that reducing policy restraint too soon or too much could stall or even reverse the progress we have seen on inflation. At the same time, in light of the progress made both in lowering inflation and in cooling the labor market over the past two years, elevated inflation is not the only risk we face. Reducing policy restraint too late or too little could unduly weaken economic activity and employment.” (The underlines are ours.) Indeed, reflecting this, we wouldn’t be surprised if the July 31 statement tweaked the phrase further, which would be a signal the Fed was moving closer to cutting policy rates. This week’s PCE inflation data were constructive. The pair of 0.2% June increases for the core and supercore metrics pulled the three-month changes down by 0.6 ppts to 2.3% annualized for the former and by 1.0 ppts to 2.6% for the latter. The six-month changes were still on the stubborn side, at 3.4% and 4.1% annualized, respectively. But a repeat of June’s monthly moves would cause both half-year trends to slip below the 3% mark for July. Shorter-term inflation trends in the 2% range are the stuff of Fed rate cuts, particularly with the labor market data weakening. Although payroll employment growth nudged above 200k in June, the past three months have registered the smallest gain (177k) since the Omicron outbreak (144k in January 2021). The unemployment rate inched up to 4.1%, matching a 33-month high. For fans of the Sahm Rule, the latest three-month average (4.0%) stands 0.4 ppts above its trailing 12-month low, just a tenth shy of the rule’s recession signal. In his recent testimony, Powell asserted: “we continue to make decisions meeting by meeting”. Between today and September 18, there are two employment and CPI reports to be released along with one on the PCE price index. We reckon a key takeaway from the statement and Powell’s comments on July 31 will be to brace for policy rate cuts next confab if the interim data continue their current themes. |
