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Economic Update Summer 2024

Economic Update Summer 2024

Economic Update Summer 2024

Recent economic data shows the US economy expanding despite aggressive monetary tightening. There are many reasons why the US economy is not in a recession. It is my view that the US economy is relatively less sensitive to the normalization of interest rates than in the past tightening cycles. For one, the US economy is now a service economy versus a manufacturing one. The economy is transforming into a digital economy enhancing productivity – less capital intensive. Corporations and households have refinanced balance sheets with ultra-low financing rates. Present debt service payments and leverage have not stalled spending. Consumer spending is bolstered by an unemployment level of 4.1% that historically has been considered natural full employment. Moreover, Fiscal stimulus have never been greater in the history of humankind since 2021, thereby propping up consumption at the cost of unsustainable Government debt growth. The same debt issuance that has helped the US economy ease into a soft landing could be the reason it stalls.

The US economy is slowing down. The US economy grew at a 2.8% annualized rate in the first quarter and is on pace to increase 1.5% in the second quarter, according to the Atlanta Fed. CNBC/Moody’s analytics projects 1.3% GDP for 2024. June’s service sector activity was considerably weaker than expected and indicated a contraction, according to the Institute for Supply Management. The ISM Services PMI came reported a contraction reading in June, the second such reading over the past here months. ADP data showed less private payroll growth than expected in June, while weekly jobless claims numbers came in higher than economists forecast. Long-term unemployment rose 1.5 million, compared with 1.1 million a year ago according to Bureau of Labor Statistics. What may be next to decline if unemployment continues to rise? Wage growth may be the next domino to fall which should curtail consumption. June’s Labor Department reported the smallest wage gains since 2021.

Headline inflation as measured by the Consumer Price Index (CPI) came in cooler than expected in June, rising 3.4% on a yearly basis. For a reference point, from 1960 to 2022, the average inflation rate was 3.8% per year according to Federal Reserve data. Yearly numbers for core CPI, which excludes the volatile prices associated with energy and food, rose 3.5% as expected.

The Core Personal Consumption Expenditures price index, the Fed’s preferred measure of inflation with less emphasis on rent cost, rose 2.8% in June drifting lower year-over-year. The Atlanta Fed's sticky-price consumer price index (CPI)—a weighted basket of items that change price relatively slowly—rose 2.4 percent (on an annualized basis) in May, on a year-over-year basis, the series is up 4.3 percent.

Although the rate of inflation is subsiding, it remains cumulatively 20% higher than it was a few years ago. Inflation has eroded the consumers’ purchasing power. Atlanta Fed research paper concludes that the level of real wages is still below the first quarter of 2021 level. Bottom line real wages have declined since 2021. The cumulative growth in the CPI since the beginning of 2021 is nearly 18% (through the first quarter of 2024). The Employment Cost Index (ECI)—one of the broadest measures of wage growth is up a little less than 15% for the same period. It is more important for households and businesses to experience economic growth that is not inflationary after what has happened to the cost of living since 2021.

The Federal Reserve in June kept its key interest rate unchanged and signaled that just one cut is expected before the end of the year. The Fed would start cutting before it hits the 2% goal because too restrictive monetary policy risks overshooting goal causing higher unemployment and perhaps a mild recession. Fed Governor Raphael Bostic said “it is important to note that inflation need not get all the way to target for me to favor reducing restrictiveness in monetary policy. If the Committee waits that long, it risks sapping too much momentum from the economy and labor market and creating unnecessary and harsh disruptions.” Chair Powell echoed Bostic’s comments by saying at Capitol Hill hearing that “Reducing policy restraint too late or too little could unduly weaken economic activity and employment,”

The CME Fed Funds Rate futures is pricing in a 75% chance of a rate cut in September, 86% in November, and a second cut in December has a 72% chance. The Fed is likely to cut this year for many reasons. For one the US economy is slowing, second inflation is cooling, and lastly the employment picture may have seen its best days for this cycle. The Commerce Department’s May’s inflation report shows inflation at its lowest annual rate in more than three years and June’s private sector payrolls report showed lower job creation.

The Federal debt has hit $34.5 trillion and is generating elevated levels of concerns on Wall Street and in Washington. It is grown nearly 50% since the early days of the Covid pandemic and is now more than 120% of the total federal economy. The Congressional Budget Office estimates that debt held by the public compared to GDP will rise to “an amount greater than at any point in the nation’s history.” US debt service payments are now one third of the budget. It is on track to surpass defense spending next year! Growing private and public sector debt is an issue for the economy. Refinancing debt at even higher future interest rates could be a financial burden for some businesses, households, and the US Government in my opinion. There could be a reckoning in the bond market next year where Bond investors dramatically reduce purchases of US Treasuries in the bond market. US Treasury yields could significantly rise causing US debt services payments to become even more onerous.
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