Viewpoint
March 15, 2024 | 14:16
March 15, 2024
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Upgrading Our Q2 Growth Forecast |
| Never underestimate consumers’ willingness and ability to spend, especially if they have jobs and money in their pockets. This is a good rule of thumb I have turned to over the last 25 years, and it still holds up well today. On that front, the current economic environment remains more favorable than anticipated despite highly restrictive monetary policy from the Federal Reserve and tighter bank credit standards. We will get the Fed’s latest view on interest rates, inflation, and the economic outlook at next week’s FOMC meeting, where we expect a modest upgrade to the description on current economic conditions since the January meeting. |
| Most of the fundamental underpinnings for sustained real consumer spending growth remain in place and will continue to support consumers’ willingness and ability to spend into Q2 and beyond, in our view. The February employment report laid to rest the idea that January’s strong start to the year was just a one-month seasonal adjustment fluke. Nonfarm payroll growth has accelerated this year. Payrolls rose at an average 212k per month in Q4; but so far in the first quarter, average monthly payrolls have increased at a 252k-per-month pace. We expect the first quarter of 2024 will be the best performance for the U.S. job market since the second quarter of 2023. Consumer confidence is on the rise too. Despite a small drop in February, the Conference Board’s Consumer Confidence Index in the first quarter is still running well above its fourth quarter average. As I discussed in more detail last week, household wealth jumped by another $4.8 trillion in the fourth quarter, and financial conditions indices show significant easing since last October as markets started to factor in peak interest rates and expectations for some Fed rate cuts in 2024. The final piece of the puzzle is real disposable income growth. It was flat in January as inflation surged, but we expect positive growth in the months ahead. Private average hourly earnings are expected to increase at 4.2% a.r. in Q1, about half a percentage point above the elevated annualized CPI inflation pace. That puts real average hourly earnings growth only a bit weaker than the pattern that has held over the last twelve months, when CPI inflation was at 3.2%, with average hourly earnings up 4.3%, and real consumer spending at a respectable 2.7% growth rate. In short, we do not yet see much holding the U.S. consumer back right now except the fact that real interest rates have risen, and it may be a bit harder to qualify for a credit card, auto loan, or mortgage than it was a year ago. While we still believe higher real interest rates matter to the growth outlook and will continue to weigh on consumer and business spending as well as job creation over the course of the year, we also know that monetary policy works with long and variable lags. Right now, the U.S. economy appears to still be running a little hot, slightly above its long-term potential growth of around 1.8%. As a result, we are upgrading our real consumer spending growth forecast for the second quarter by half a percentage point to 1.6% annualized. This lifts our U.S. real GDP growth forecast for the second quarter to 1.2% a.r. from 0.8% previously and raises our 2024 year/year and Q4/Q4 GDP growth forecast by a tenth of a percentage point to 2.3% and 1.5% respectively. That is still a measurable slowdown in 2024 GDP growth on a Q4/Q4 basis, even as the risk of a sharp consumer spending pullback in Q2 has diminished. |
FOMC Preview: Pause Persists amid QT Hints |
| The Fed should keep policy rates unchanged for the sixth consecutive meeting, after signaling so at the last confab. The target range for the fed funds rate was last lifted in July to 5.25%-to-5.50%. As to when it will be lowered, the FOMC altered its forward guidance last meeting saying that it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent”. Even after hefty high-side surprises by January’s CPI and PCE price index, Chair Powell still said “when we do get that confidence, and we’re not far from it, it will be appropriate to dial back” policy restraint. However, in the wake of this week’s high-sided CPI surprise for February (see Sal’s Thought), we suspect Powell might sound more circumspect about timing in the presser. Meanwhile, the theme of economic resiliency has continued to mostly play out, leading us to lift our forecast for Q2’s ‘low-tide’ growth mark from 0.8% annualized to 1.2%. Combined with a (now more pronounced) theme of inflation stubbornness, we suspect the Fed’s easing appetite has waned, which could get reflected in the ‘dot plot’. December’s Summary of Economic Projections (SEP) had 75 bps of rate cuts by the end of this year (to a midpoint of 4.625%) and 100 bps next year. There were 75 bps in 2026 with the midpoint (2.875%) still above the longer-run level (2.5%). For 2024, six participants were at the median, with five projecting a lower rate (more easing) and eight forecasting a higher one (less easing). It will take only two of the six shifting to the higher side to turn up the median. In the event, we reckon this would cascade across the out-years, amid already lots of chatter about a higher longer-run rate (‘r-star’). Even if the medians don’t shift, we reckon higher means will still likely result. Elsewhere in the SEP, mirroring the themes of economic resiliency and inflation stubbornness, there’s net risk of slight upgrades (a tenth or two) to the 2024 and 2025 projections for real GDP growth along with total and core PCE inflation. Powell had said that the Committee was “planning to begin in-depth discussions of balance sheet issues” at this meeting. We’ll be listening closely in the presser for clues about quantitative tightening tapering and QT continuing after policy rate cuts start. Powell has maintained that reducing rates and continuing to run off the balance sheet could occur together because both are aspects of policy normalization. However, last presser (and for the first time in our recollection), Powell said “from a strict monetary policy standpoint, you could say we’re loosening along with tightening”. Such confusing optics matter for the Fed. For the record, our working assumption is that monthly roll off of Treasuries will be tapered quickly from $60 bln to $30 bln, beginning when rate cuts start (July), with QT continuing into mid-2025. The continuation will be ‘advertised’ as balance sheet shrinking shifting from being a tightening complement to rate hikes to being a policy-neutral companion to rate cuts, with any lingering QT impacts written off as technical pressures. Banking system reserves currently average above $3.6 trillion, more than when QT started, as sharply reduced activity in the overnight reverse repo facility has absorbed QT so far. Eyeing a reserves level below $3 trillion, we judge the Fed won’t feel compelled to start tapering any sooner or end QT much earlier. Bottom line: Rate cuts and QT tapering are coming, but not for a while yet. |
Inflation: Good Things, Bad Service |
| After January’s steamy CPI release, investors waited anxiously for February’s results. While the details weren’t quite as hot, the report did nothing to allay concern about sticky prices. The headline index rose the most in six months, by 0.44%, lifting the annual rate to 3.2%. Core prices cooled a tad to 0.36% m/m and 3.8% y/y, but the shorter-term annualized moves are perched modestly above the yearly pace, indicating inertia. Base effects will help for a while; but, come summer, unless the monthly core pace ebbs, the yearly rate will turn higher—not a good look for the FOMC should it jump the gun on rate cuts. It’s all about services. In fact, after eight successive declines, core CPI goods prices rose only slightly last month and remain below year-ago levels. While gas prices rebounded (and oil has more recently punched above $80 a barrel), fuel costs are still down almost 4% in the past year. Food prices held steady, extending a slowing trend from over 11% y/y in mid-2022 to almost 2% today. The price of a motor vehicle has reversed lower in the past year after stunt-driving during the pandemic. Not so for services prices, however, which leaped 0.5% last month and are still running north of 5% on a yearly basis. This reflects the glacial slowing of still fast-rising rent (nearly 6% y/y) as well as broader underlying pressure. Stripping out rent and energy services, ‘supercore’ prices rose 4.3% y/y, accelerating about 6% annualized in the past six months and almost 7% since November. Drivers beware—whatever you save after leaving the dealers’ lot could be lost when repairing and insuring the vehicle, with costs up 7% y/y and 21%, respectively. There also appears to be little imminent relief in the pipeline for consumers, with producer services prices speeding up 5.0% annualized in the first two months of the year. Don’t expect much of a cooldown in the February PCE price report, either. Seasonal effects may have warmed the inflation data, in which case we could see a calmer March report. But if that one also lands with a thud, inflation could prove stickier than even we expected. Improved supply chains and lower resource prices have aptly corralled goods prices, but sturdy consumer demand and brisk wage gains are still fanning increases in the large services sector. The latest inflation news is probably not a giant pothole on the road to price stability, but it does highlight that the last mile will be bumpy. This risks a longer period of restrictive policy to smooth the way. While a soft landing is still in sight, it might require a lengthier runway. |
