Economic Update - Patience is a virtue! - Fremont Bank

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APRIL 2024

Is patience a virtue? Some of the most notable investors have taken a “patient” view while investing in the equity market. As for the bond market, it holds true when it comes to the Fed reducing interest rates. Again, at their recent meeting in March they held the fed funds rate steady and maintained a wait-and-see approach to incoming data.

How long do we need to be patient before the Fed starts to ease rates?

It’s not just timing, it’s also the velocity of cuts. Fed Chairman Jay Powell stated they need greater confidence that inflation is tracking closer to the Fed’s 2% target before they start to reduce interest rates. Yet, at their last meeting, inflation was revised up for the next two years and is projected to be above their target. The core PCE for 2024 forecast went from 2.4% to 2.6%. March’s report came in at a relatively high 2.8%, so core PCE would have to average 0.19% month over month to reach the revised forecast by year-end. It seems that the Fed has conceded to a higher inflation rate than 2%.


The Fed also cited an improving labor market, yet Powell said “a surprise increase in unemployment could prompt the Fed to lower rates.” So, now they are no longer singularly focused on crushing inflation. With the move up in their forecast for inflation and now bringing in employment as a factor to consider, the intent on cutting this year becomes clearer.


Are we all too serene?

Recently, headline economic reports have been positive. Jobs remain strong, inflation has come down, and our economy is expanding. However, beyond the headlines employment is showing weaknesses: many companies are laying off employees, temporary staffing is declining, and the hours worked have shortened. These are signals of a potential slowdown.


The concern with the view of a strong job market is that we are continuously seeing the ADP Private Payroll Report and the government’s non-farm payroll report diverge along with large revisions after the reports. Over the last few months, ADP has averaged 136K jobs added to the workforce, whereas non-farm payroll has averaged 281K.


The other concern within the non-farm payroll release is the establishment and household survey. The household survey (the one that produces the unemployment rate) showed that total employment declined on net by 308K over the last six months. The report has no duplication of individuals, because they are counted once even if they hold more than one job. Whereas for the establishment survey, workers can appear on more than one payroll and be counted separately. This should give us pause on how much we can conclude from these reports.


Another way to look at inflation:

Core PCE falling from its mid-5 handle in 2022 sounds good. But the San Francisco Fed takes another view and splits core PCE into cyclical and acyclical components. Cyclicals are sub-components most sensitive to Fed interest rates and acyclical is sensitive to industry specific factors (think supply chain). Acyclical inflation has fallen from 3.64 to 0.89, almost to its pre-pandemic level of 0.55. However, cyclical core PCE has only come down from 3.05 to 2.01 and remains at its 40-year highs. One may believe that inflation has fallen despite the action of the central bank.


Is this market different?

Some economists have cited an inverted yield curve as the best predictor of a US downturn. Throughout history, we have seen an inverted curve before all previous 10 recessions with a lag of 12-18 months. We are now beyond that time frame—we have been in an inverted yield curve for 21 months! But in many ways, it has already accurately predicted many of the drivers that would normally lead to a recession. Yet, this inverted yield curve hasn’t created recessionary conditions as they normally would have.


Some contributing factors, such as excess savings, have been unusually high in this cycle, as well as a flood of fiscal stimulus and continued government spending. This contractionary monetary and an expansionary fiscal policy environment has led to aggregate demand higher, interest rates higher, and government spending as a portion of GDP much higher. This flow of money in the market has supported spending, which has reinforced our economic growth so far.


Can this last?

For government spending, possibly, but that is dependent upon Congress. As for consumers, they are consistently outspending their income, which is a concern. Personal spending shot up 0.8% in last week’s report, 0.6% higher than the previous month, while personal income was up only 0.3%, 0.7% less than the previous month.


Household debt reached $17.5T in Q4 2023, according to the latest reports. Credit card balances increased $50B to $1.13T, while mortgage balances rose by $112B to $12.25T. Auto loans balances rose $12B to $1.61T. Meanwhile, delinquency rates increased for all debt types except for student loans. Consumers have drained their savings and are more reliant on debt, which doesn’t seem sustainable.


So, when will they cut rates?

While recent economic reports have been mostly positive, it takes a little impatience or restlessness to sift through the reports. So, the question is when and how many times will the Fed cut rates this year? Now that they are not just focused on inflation but concerned about the labor market, we should be skeptical about their projected three 25 basis point cuts. Yet, if they are bent on lowering rates, it’s likely to be a summer cut. If all these economic indicators continue to go in their favor, expect another cut in September. However, sometimes things just don’t always go as smoothly as we like. So, although current conditions may feel a little serene, sometimes it’s good to be a little impatient and not rely on the headline news.


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