FED Decision and Mixed Economic Signals

Economic Data Send Mixed Signals

Today,  the market received mixed signals from the economic data releases (GDP, jobless claims) and this outlook is just ahead of the FOMC meeting next week.   For example, Q1 GDP came in at 1.6% annualized rate, much softer than the 2.5% expected and down from 3.4% in Q4 2022. Personal consumption was weaker than anticipated at 2.5%.  The core PCE price index for Q1 was 3.7% year-over-year, higher than the 3.4% expected, showing inflation remained sticky. Initial jobless claims for last week were 207,000, lower than the 215,000 expected, indicating a still-strong labor market.

As can be seen, the data was seen as mixed, with weak GDP growth but hotter inflation and a tight labor market. This means uncertainty around interpreting the mixed signals and what it means for the Fed’s rate path going forward. Some see the inflation/jobs data as more pressing for the Fed. In addition, concerns that the tight labor market and elevated inflation could prevent the Fed from cutting rates soon, despite slower growth.  Finally, questions remain about the durability of economic drivers like business investment and consumer spending.

Fed officials will scrutinize the data closely ahead of next week’s FOMC meeting to gauge if rate cuts are warranted soon or if more tightening is needed.  Investors will watch for revisions to GDP and monitor upcoming PCE inflation data tomorrow for further clarity.  Economists will update growth/inflation forecasts based on the latest readings.  For the markets the next major catalyst is the PCE inflation data released tomorrow (Friday) which is then followed by FMOC meeting on Friday the 3rd of May.

Summary: The US economic growth experienced a sharp downshift last quarter, with GDP advancing at a 1.6% annualized rate due to restraints like less inventory accumulation and a wider trade gap. However, resilient household demand and business investment helped generate faster inflation. Final sales to private domestic purchasers rose at a 3.1% rate, indicating underlying demand strength. The Federal Reserve’s progress on tamping down inflation stalled as underlying price pressures accelerated at a greater-than-expected 3.7% clip last quarter.

Key Points:

• GDP advanced at a 1.6% annualized rate, below expectations, due to restraints like less inventory accumulation and a wider trade gap.
• Final sales to private domestic purchasers rose at a 3.1% rate, indicating strong underlying demand.
• Inflation accelerated at a greater-than-expected 3.7% clip last quarter, leading to potential pressure on the Fed regarding interest rate cuts.
• Despite the softer economic growth, personal spending increased at a healthy 2.5% pace, with a significant gain in services outlays.
• President Joe Biden faces challenges with GDP and inflation figures, as consumer sentiment remains stagnant and voters in key swing states are pessimistic about the economy.

In short, these economic data points bolster the argument that the FED does not need to cut rates at this point.  The data was confusing and it should be noted that GDP data gets revised often with perhaps the most reliable leading indicator being the job figures.  However, the FED can only look at the unrevised data to make decisions since this is all they have.

This marks a sharp change in market expectations that had hoped for six to seven rate cuts at the start of the year.  This is no longer the case as we may see two or three maximum or potentially even zero cuts.  There is even a chance of a rate hike.  This will have some implications politically.

Political Challenges Ahead 

President Joe Biden’s administration faces an uphill battle in navigating the challenges posed by the recent economic data. The combination of slower GDP growth and accelerating inflation puts pressure on policymakers to strike a delicate balance between supporting economic recovery and controlling rising prices. With consumer sentiment remaining stagnant and voters in key swing states expressing pessimism about the economy, the administration must carefully craft its messaging and policy responses to address these concerns.

In our opinion the most likely timing for a rate cut is in September with the strong possibility of no further cuts until after the election in November.   The cut in September will most likely for 0.25.

Market Impact 

The bond market yields ticked up with the 2 year now at 4.9747 (an increase of 0.0478) and the 10 year at 4.6770 (an increase of 0.0353).  It should be noted that when yields went up from 3.8% to over 5% earlier, we saw the market correct by 10%.  So far the market has dropped by about 6% with yields just below the 5% level.  If they go above the 5% level then we could see another 4% correction.

There are also implications for the FX markets since this means further support of the US Dollar.  The US Dollar Yen rate is now approaching 156 which is going to put further pressure on the Japanese.  A comfortable rate for businesses would be around 130 since a weak Yen at 156 makes import purchases much more expensive for both business and consumers in Japan.