Recent economic data suggests that the U.S. economy is indeed in the midst of the soft landing that so many bears had claimed was impossible.
Specifically, inflation has slowed to a level with which the Federal Reserve appears to be comfortable, and there are multiple indications that the central bank is ready and willing to cut interest rates starting sometime in the second quarter of next year. Unsurprisingly, Wall Street, which remains obsessed with interest rates, is celebrating this situation.
But I think it will be important for investors to closely monitor economic data going forward. Why? Although I don’t believe a recession is very likely to occur in 2024, I would not completely rule one out.
Signs of a Soft Landing
In October, the Consumer Price Index (CPI) was unchanged versus September, while the “core” CPI, which excludes food and energy, climbed just 0.2% compared with the previous month. Similarly, the Personal Consumption Expenditures (PCE) index, excluding food and energy prices, the Fed’s favorite measure of inflation, increased just 0.2% in October versus September.
I believe that the central bank is very happy with prices increasing at an average monthly pace of 0.2%. Providing evidence of this assertion, Fed Governor Chris Waller, who’s viewed as an “inflation hawk,” on Nov. 28 said that if inflation continues to ease “for several more months … three months, four months, five months … we could start lowering [interest rates] just because inflation is lower.”
Fed Chair Jerome Powell, in a clear effort to prevent inflation from reaccelerating in the near term, made the obvious point that it would be “premature” to talk about cutting rates immediately. But at the same time, he suggested that the Fed would keep rates steady at its next meeting later this month, and he did not rule out rate cuts in 2024. Moreover, Powell added that rates are “well into restrictive territory.”
Given these points, I think that the Street, which believes there is a 100% chance of a rate cut in May 2024, could very well be correct.
Meanwhile, the Fed, which has proven rather adept at estimating GDP growth in recent quarters, is estimating that the economy will grow at a 1.2% annualized clip during the current quarter. Such an increase would be quite consistent with a soft landing scenario.
Reasons for Optimism and Reasons for Caution
Obviously, expanding at a 1.2% annualized rate is not that far away from a contraction. But there are a few caveats which make me believe that a recession is probably not around the corner.
For one, the real inflation rate is probably significantly lower than the CPI, due to the lag in rent declines being reflected in the index and the inclusion of “owners’ equivalent rent,” which nobody actually pays, in the index. Therefore, “real” GDP growth is probably at least 0.3-0.5 of a percentage point higher.
Secondly, the Fed is estimating that the PCE index will rise by 1.8% in Q4. Since 70% of the actual U.S. economy is based on consumer spending, the latter estimate bodes well for the economy’s direction going forward.
And thirdly, businesses are likely to become more optimistic going forward as inflation continues to ease and as they start to anticipate rate cuts by the Fed in Q2 2024. That optimism, in turn, should cause them to step up their hiring and investment
Still, given the apparent, marked slowing of the economy during the current quarter, I think investors should closely watch economic data going forward.
In particular, if job growth or consumer spending begin to show signs of sharply decelerating, it may be time to become less optimistic about the U.S. economy and American stocks.
On the date of publication, Larry Ramer did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
