Q1 GDP is below estimates … how traders are sizing up rate-hike probabilities … the Fed’s rock-and-a-hard place … how much longer can the consumer prop up the economy?
Inflation up, growth down.That was the quick takeaway from this week’s economic reports, revealing the boxed-in position in which the Fed finds itself.Yesterday morning, investors received the latest numbers on the Q1 Gross Domestic Product (GDP) and Personal Consumption Expenditures (PCE) Price Index.Let’s go straight to Bloomberg:
The US economy was slowing even before the brunt of any credit crunch stemming from the recent bank failures, while inflation accelerated, highlighting the enormous challenge faced by the Federal Reserve.Gross domestic product rose an annualized 1.1% in the first quarter, notably less than the median forecast for 1.9% in Bloomberg’s survey, Bureau of Economic Analysis data showed Thursday…Frustratingly for the Fed, the central bank’s preferred core gauge of prices, which excludes food and energy, picked up to 4.9% in the January-through-March period, the quickest pace in a year.Meantime, a separate report underscored enduring strength in the labor market, with weekly jobless claims unexpectedly dropping.
Given these data, it’s hard to make a slam-dunk case for a dovish Federal Reserve. Wall Street traders seem to agree.
To illustrate, take the CME Group’s FedWatch Tool
The FedWatch Tool measures how traders are sizing up the probabilities of various target rates from the Fed after upcoming FOMC meetings.Two days ago, prior to the release of the economic reports we just covered, it put the odds of a 25-basis point rate-hike next week at 72.2%.Yesterday, after this GDP/PCE/labor market releases, that number shot up to 86.8%. It’s nudged even higher as I write Friday morning to nearly 88%.But more interesting is how the probability changed for June.A rate-hike next week has been the going expectation for a while. But what happens at the Fed’s June has been the wildcard.Will we finally get the Fed pause? Or will Fed hawks push the target rate even higher?Well, a pause is still the majority expectation (65.4% odds). But after yesterday’s data, the probability of another hike in June nearly doubled, jumping from 13.7% the day before to 26% Friday morning.
But even as the Fed is all-but-certain to raise rates next week, the economy is sending signals that it might not be able to handle higher rates
In his recent Daily Notes from Early Stage Investor, our hypergrowth expert Luke Lango offered an excellent summation of the economy’s warning signals, as well as what the Fed needs to do:
Consider this: Pretty much every district Fed survey for April recorded huge drops in new orders and sales to, or at least near, decade-low levels.[On Tuesday], we saw a huge drop in the Philadelphia Fed Services, Dallas Fed Services, and Richmond Fed Manufacturing headline indices all to their lowest levels since 2010, excluding the COVID-19 pandemic period. Also, consider this: Pretty much all those district Fed surveys recorded huge drops in price pressures in April to decade-low levels, too. Oil prices are dropping. Copper prices are dropping. Truflation data is trending lower. Home price growth continues to moderate. Consumer confidence and expectations are crashing. Yes, all of that data means recession risks are rising. But it also means inflation risks are subsiding, and perhaps altogether disappearing. The economy has not yet collapsed. Inflation has collapsed. Therefore, we continue to believe the economy is in this “sweet spot” wherein the Fed can guide us to a soft landing. But only if they pause their rate-hike campaign by the summer.Else, we will get a recession.
We agree with Luke that all sorts of economic data are revealing major cooling on the inflation front. The wrinkle, however, are reports like this week’s PCE Price Index that shows stickier inflation than the Fed would prefer.How will the Fed interpret such reports? And how will that translate into its policy decisions?
Luke is confident the Fed knows exactly how weak the economy has grown and so a pause is imminent
Here’s his take:
…The Fed is not dumb, or deaf, or blind. They know the state of the economy. They see the data. They hear what everyone is saying. And they will pause by June, thereby stabilizing the economy, reducing recession risks, and sparking a big stock market rally. On confidence for a Fed pause by June, we remain steadfast dip-buyers in today’s market, even in the face of bad economic data. Remember: The Fed ultimately caused this economic slowdown and bear market. They have the power to end it, too, and they will soon.
Luke is so confident in this expectation of a Fed pause and a budding bull market that yesterday afternoon, he held a special live event to detail why he believes now is one of the best market opportunities in decades.You can watch a free replay of the event by clicking here.
There’s one final complicating variable in all of this – the U.S. consumer
The U.S. consumer makes up 70% of our GDP. So, if you want a bead on recession risk and the impact of the Fed’s rate-hikes to date, check in on the health of the U.S. shopper.At first glance, it appears that the U.S. consumer is indestructible.Here’s MarketWatch:
Consumer spending rose at a robust 3.7% annual pace to mark the fastest increase in almost two years…[Consumers] are enjoying the best jobs market in decades, for one thing. The unemployment rate is near a 54-year low and most people who want a job can find one.Incomes are also rising rapidly in light of fierce competition for labor, though not quite enough to keep up with inflation.What this means is that households have money to spend, and they are spending it.
But things may not be quite as rosy as they appear.As we’ve noted here in the Digest, what if this robust spending has been occurring thanks to excess savings from the pandemic, as well as growing debt?That would be problematic, as it would provide a false representation of consumer strength, masking cracks under the surface.Here’s NBC News with what those cracks look like:
U.S. households have been whittling down their savings and taking on increasing amounts of debt, putting many in a weaker position to weather an economic downturn that has grown all the more likely following recent turmoil in the banking industry…Over much of the past year, as inflation has hit its highest levels in decades, consumers have largely been able to keep increasing their spending…But data indicates that wages haven’t kept up with inflation over that period. As a result, Americans have increasingly turned to their credit cards and savings accounts to keep up their spending habits…Americans have spent down about half of the savings they accumulated during the pandemic, going from about $2.1 trillion in excess savings from the influx of government stimulus checks and reduced spending during lockdowns to around $900 billion as of the third quarter last year, according to a report by J.P. Morgan.At the same time, the percentage of people’s paycheck going into savings has fallen to about half of what it was prior to the pandemic, according to data from the Federal Reserve Bank of St. Louis. Meanwhile, the amount of debt Americans are carrying has soared. Credit card balances increased by $61 billion to a record high of $986 billion in the last quarter of 2022 — a rapid reversal from two years ago when Americans were paying down debt with stimulus checks…
