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Economic Update January 2024

Economic Update January 2024

The U.S. economy is currently in an elongated late cycle that has experienced rolling recessions specific to certain sectors in economy such as real estate. The risk of a recession has decreased and the odds of a soft landing in the US economy have risen as the Federal Reserve’s (Fed) is ending its tightening cycle. The lag effects of monetary policy should continue to weigh on parts of the US economy this year. Higher rates for longer can weaken consumer demand, particularly if they persist. A weaker consumer can impact corporate revenue and the labor market. So far, the Fed has been fortunate with inflation trending lower and its restrictive monetary policy breaking economic growth without causing widespread damage to the US economy in the form of recession like six percent unemployment.

The third estimate of Q3 gross domestic product showed the US economy grew in Q3 at a slower pace than previously estimated amid a downward revision to consumer spending while inflationary pressures eased. GDP Now forecast 2.5% growth for Q4. The yield curve is flattening implying slower growth lies ahead. The Fed is projecting U.S. economic growth of 1.4% and CNBC/Moodys analytics projects 1.3% GDP for 2024. Economic growth projections have the US economy flying close to stall speed right above a recession yet is still a far better outcome than a recession. Rate cuts would accelerate economic growth.

Whereas The Conference Board is forecasting a short and shallow recession in the first half of 2024. The US Leading Economic Indicators (LEI) continued its eighteenth month decline in November. Housing and labor market indicators weakened. The US LEI suggests a downshift of economic activity ahead. The December ISM Manufacturing index remained in contraction territory. Manufacturing is one third of the US economy. The ISM Non-Manufacturing Index (Services), which is more important than the manufacturing, services are two-thirds of the US economy, is still in expansion territory. The Composite PMI (Manufacturing and Services) index reports that the US economy is expanding. Corporate earnings growth is highly positive correlated with PMI figures. Positive figures for PMI are good news for corporate earnings.

Albeit a lagging indicator, the latest jobs report supports a soft-landing scenario. The Labor Department’s most recent initial jobless claims report shows the labor market is resilient despite tighter financial conditions. Initial job claims are surprisingly low at this point in the cycle. Initial jobless claims have risen 2.35% YOY and remain subdued. Continuing claims are higher YOY by 15%, coming off an ultra-low level. The Conference Board’s LEI indicators show a weakening in labor markets for last November. A gradual cooling in the labor market will allow the Fed a reason to cut rates. The Fed projects unemployment to rise from 3.8% to 4.1% in 2024 which is way below unemployment associated with a recession. The Fed may cut rates by mid next year because the Fed’s measure of inflation, PCE core inflation, is projected to fall to 2.4% this year closer to it 2% target. Given PCE inflation meets Fed’s projection this year, there is no longer a need for the Fed to hike again. Instead, with the Federal Funds rate sitting at its highest level in some 22 years, there is more a need to cut because tighter credit conditions are a headwind for consumers and eventually create deflationary environment – that would place the US economy going the wrong way on the highway to prosperity for all.

The US economy is less sensitive to higher rates as in past tightening cycles because services are seventy percent of the US economy. Manufacturing industries are impacted by higher rates more than Service industries. In general, businesses and consumers remain in decent shape. Moreover, business and consumer balance sheets have improved significantly since January 2020 having a positive effect on household wealth and spending. Household financial obligations as a percentage of disposable personal income are at an extremely low historical level according to FRED data. The same can be said for household debt service payments as a percentage of disposable personal income. A preponderance of mortgage debt is also fixed at ultra-low rates well below the 7.74% historical average reported by Freddie Mac since 1971. Mortgage rates are projected to decline to the 5-6% range this year. Lower rates this year would have a positive impact on so many industries such as housing, retail, and Bank lending. Lower borrowing costs and gas prices are supportive of consumer spending which accounts for sixty-five percent of the US economy. The consumer could be the reason there is no recession this year if there is credit relief. Financial conditions, as measured by The Chicago Fed's National Financial Conditions Index, have moved from tighter to easier in the last few months.

Although inflation over the past couple of years has increased the cost of living for all Americans, it is the rate of inflation that the capital markets trade off. The Consumer Price Index (CPI), which measures costs across a broad array of goods and services was up 3.1% from a year ago in November, according to the Labor Department. Given the drop in energy prices, the CPI is now trending lower below 3%! The Fed thinks core inflation is a better indicator of current inflation because it excludes volatile energy and food prices. Core CPI is up 4.0% year-over -year. More recently and importantly, Core CPI has fallen to 1.9% annualized rate over the last three months as rent and wages decelerate. Core CPI is more likely to drop into the 3’s this year. Lower inflation is the reason stock and bond markets have rallied. Chair Powell noted inflation is “making real progress.” Powell noted that over sub-annual rates of change, the picture was even more positive: “if you look at the six-month measures, you see very low numbers.” Later in the press conference Powell noted that waiting to get down to 2.0% core inflation on a YoY basis would be “too late.” Instead, “you’d want to be reducing restriction on the economy well before 2% so you don’t overshoot”. The Fed Core PCE inflation projection was lowered to 2% from 2.3%, the data showed.

The oil market is well supplied despite OPEC cuts earlier in the year. Previously sanctioned countries like Iran and Venezuela are ramping up production and so are non-OPEC countries like Brazil. The US is producing a record amount of oil and could increase production even more if necessary. Natural gas production is also easy to ramp up if necessary. The price of oil is projected to rise in 2H but should not pose a threat to consumers wallets nor inflation because of supply.
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