Viewpoint
May 03, 2024 | 14:58
May 3, 2024
Economics
Economics
Economics
Economics
Economics
Economics
Choppy Economic Waters Keep Rate Cut Hopes Alive |
| As Friday’s weaker-than-expected employment report for April underlined, there is growing evidence that labor market rebalancing is already well underway. Payroll growth downshifted to a much more comfortable 175k jobs from a scorching 315k in March. The unemployment rate ticked up to 3.9% and is now a half a percentage point above its expansion low, while the yearly growth in average hourly earnings slipped below 4.0% for the first time since June 2021. The March JOLTS data revealed a bigger than expected drop in job openings to 8.5 million, the lowest level in more than three years. We saw further declines in new hires, separations, and quits, all pointing to deceleration in the demand for labor and a growing reluctance for employees to leave their current jobs in search of greener pastures. The ratio of job openings to unemployed reached a record high of 2.0 jobs per unemployed in March 2022 but has since slipped to just 1.3 jobs in March (Chart 1). This ratio is now back to where it was before the pandemic began. This is all mounting evidence that two years of labor shortages and job market “overheating” are losing some serious steam. |
| While not yet visible in the wage growth measures like the Employment Cost Index that surged in the first quarter, the extent of the labor market rebalancing seen so far points to more moderation of wage growth ahead. Wages are a notorious lagging economic indicator. So, the recent acceleration in wage growth may just be employers and employees catching up from the strong consumer price inflation over the past few years rather than a signal the labor market is reheating, or labor demand and labor supply are once again moving away from better balance. The rebalancing of supply and demand is also visible in a growing number of economic indicators. Bloomberg’s U.S. economic surprise index has turned slightly negative for more than a month now with indicators generally missing analyst forecasts to an extent we haven’t seen since the first half of 2023 when GDP growth was clocking in at a more subdued 2.0% annualized pace (Chart 2). Most of the deterioration and economic indicator misses so far appear to be centered on softer business and consumer surveys, while the harder housing, industrial, labor market, and retail indicators have remained relatively resilient. Case in point, the ISM Manufacturing PMI for April just this week fell back into contraction territory where it has lurked for most of the last two years as the Services PMI dipped below 50 for the first time in 16 months. Meanwhile, the Conference Board’s Consumer Confidence Index suffered a serious setback last month as consumers’ views of the labor market, income growth, and the economic outlook sank. Of particular interest is the sharp deterioration of confidence in the labor market (Chart 3). The differential between consumers that saw more jobs verses fewer jobs six months from now plunged to a minus 7.9, the lowest level in more than a decade. I don’t take a lot of comfort in the current resilience of the harder economic data as a prolonged deterioration in survey-based data can often lead to weaker “hard” data over time. In short, we expect the mounting evidence of labor market rebalancing, and softening consumer and business surveys to foreshadow a noticeable cooling of consumer and business spending growth in the months ahead. This will reduce the ability of a broader cross-section of businesses to keep raising prices at the pace we have seen so far this year and crimp their profits. While the link to consumer inflation is not immediate or iron clad, due to the potential for more global supply and energy shocks, the encouraging rebalancing trends evident in recent data still point to a path for Fed rate cuts sometime this year even if delayed. |
Fed Policy: Hold Horizon Prolonging |
| The FOMC kept policy rates unchanged on May 1, with the fed funds target range at a 23-year high of 5.25%-to-5.50%, which is where it has been since July. And the Fed signaled that the range could remain here for many more months. The policy statement added the phrase: “In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective.” This stalling of progress was also acknowledged in the risk assessment, with the Fed no longer judging that “the risks to achieving its employment and inflation goals are moving into better balance”. Instead, the judgment is now that the risks “have moved toward better balance over the past year”. (The emphases are ours.) The statement also repeated the forward guidance that it won’t be appropriate to reduce policy rates until the FOMC “has gained greater confidence that inflation is moving sustainably toward 2 percent”. In the press conference, Chair Powell reiterated what he first mentioned on April 16: “so far this year, the data have not given us that greater confidence” and “gaining such greater confidence will take longer than previously expected”. In the meantime, the Fed was prepared to hold rates at current levels “for as long as appropriate” while still considering rate hikes to be “unlikely”. And, as was the case at the mid-April event, absent in Powell’s comments was the prior messaging (which had been employed as recently as April 3) that “it will likely be appropriate to begin dialing back policy restraint at some point this year”. The data have surprised so much to the high side that the Fed’s confidence in its forecasts has eroded, making it harder to be even vague about the timing of rate cuts. Powell said we should “see further progress on inflation this year. I don’t know that it will be enough, sufficient [to trigger rate cuts], I don’t know that it won’t. I think we’re going to have to let the data lead us on that.” There is still time for the data to lead, and April’s employment report was a step in the right direction. Payrolls expanded by 175k (a 6-month low), the jobless rate jumped a tenth to 3.9% (a 27-month high unrounded), and the yearly change in average hourly earnings slipped under 4% for the first time since June 2021. As such, we still expect a couple of quarter-point rate cuts this year. For example, between today and the September 18 policy announcement, there are four more employment reports and the same number of PCE inflation readings. And there are five CPI reports forthcoming. Finally, as was signaled last meeting, the Fed announced changes to its quantitative tightening (QT) program. The monthly run-off cap for Treasuries was lowered to $25 bln from $60 bln beginning June 1st, with the (currently non-binding) MBS cap staying at $35 bln. When these latter payments ever get above the cap, they’ll be reinvested in Treasuries. The tapering of Treasuries was a bit more than expected, likely reflecting the Fed’s heightened sense of caution as QT starts getting more fully reflected in reserves reduction (so far, reduced overnight reverse repos have absorbed the brunt). Bottom Line: Rate cuts are still many folds more probable than rate hikes. However, whether the Fed will judge that there has been sufficient disinflation progress made to start them by year-end has become more uncertain. |
