Odds Favoring a June Rate Cut Keep Slip Sliding Away
Upward revisions for both Q4-2023’s real GDP and March’s consumer sentiment index, as well as another historically low reading for initial claims for unemployment insurance and the ISM’s first expansionary reading for US manufacturing since September 2022 lowered the implied probability of a June 12 rate cut from March 25’s 70% to a recent 58%.
In addition, the recent jump by the 10-year Treasury yield to 4.33% suggests the credit market wants the federal government to cut spending and hike consumption-related taxes ASAP to complement Fed efforts to slow the economy to a disinflationary pace.
The historically low 210,000 initial state unemployment claims of the week-ended March 25 were down by -13% from a year ago. Thus, despite a rise by fed funds from March 2023’s 4.88% to a now 5.38%, the labor market has yet to soften by enough to support claims of an extended deceleration of price inflation. Should the Fed have hiked its benchmark interest rate to 5.63%?
Softer job market would facilitate a June rate cut …
The Bloomberg consensus forecast of a June rate cut (from 5.38% to 5.13%) stems from expectations of a mild rise by the average monthly addition to payrolls from Q4-2023’s 212,000 to Q1-2024’s 230,000 jobs. Thereafter, the consensus projects a drop by the average monthly addition to payrolls to Q2-2024’s 150,000 new jobs.
In view of how payrolls grew by 252,000 jobs per month during 2024’s first two months, getting to 230,000 new jobs per month for 2024’s first quarter requires the addition of no more than 186,000 jobs to March’s payrolls, all else being the same. Nevertheless, a recent consensus forecast calls for a 200,000 jobs addition to payrolls in March implying the creation of 235,000 jobs per month for 2024’s first quarter, where the latter assumes an unchanged reading of 157.808 million jobs outstanding for February. My sense is if Q1-2024’s average monthly addition to payrolls approaches at least 250,000 jobs, the likelihood of a June 12 rate cut fades materially.
Predicting the number of outstanding jobs offers a better way …
Because of the magnitude of recent revisions for the payrolls of the two previous months, it might be better to simply forecast the number of outstanding jobs for the month in question. Combining February’s 157.808 million jobs outstanding and the recent consensus projection of an addition of 200,000 jobs in March implies the consensus expects March’s payrolls to show 158.008 million jobs outstanding, all else the same. To the extent, March payrolls are above or under the latter forecast of 158.008 million jobs will indicate the degree to which jobs growth tops or falls short of expectations.
How the consensus view of real GDP fits its outlook for fed funds …
The consensus also foresees a deceleration by real GDP’s annualized quarterly growth rate from Q4-2023’s 3.4% to 2.0% for Q1-2024 and 1.4% for Q2-2024. There will be no rate cut if real GDP’s annualized quarterly growth rate stays close to 3% or higher.
Following June 12’s projected rate cut to 5.13%, the mid-March consensus foresaw two more Fed rate cuts in 2024 – one at the FOMC’s September 18 meeting to 4.88% and the other at the FOMC’s December 18 meeting to 4.63%. Second-half 2024’s outlook for the federal funds rate was accompanied by consensus expectations of merely 120,000 new jobs per month during 2024’s second half and annualized quarterly real GDP growth rates of 1.2% in 2024’s third quarter and 1.5% in the final quarter.
In turn, the consensus believes the 10-year Treasury yield will sink from a recent 4.2% to 3.8% by the end of 2024. Nevertheless, where interest rates end 2024 will also depend on the outcomes of November 5’s presidential and congressional elections. The Treasury bond market will eventually seize up if the federal government budget deficit continues to average more than 5% of GDP in the context of a growing, full employment economy. According to this scenario, an unexpected and very burdensome lift-off by benchmark interest rates will trigger both a recession and deep price declines for equities and business debt.
Higher energy prices menace the benign inflation outlook …
Higher energy prices threaten to bring at least a temporary end to progress at slowing consumer price inflation.
The price of gasoline increased sequentially in 9 of the 10 weeks ended March 25. Over this ten-week span, gasoline’s price posted a cumulative gain of 14.5%. March’s monthlong average price for gasoline advanced by 6.7% from its February 2024 average.
This warns of a monthly increase by the CPI's March gasoline price index of between 0.5% and 1.0%. In turn, March’s headline CPI will probably rise by at least 0.3% monthly.
As shown in the following table, after slowing from January 2023’s 5.5% to January 2024’s 2.4%, the annual rate of PCE price index inflation edged up to 2.5% in February. Nevertheless, the annual rate of core PCE price index inflation eased from January 2024’s 2.9% to February’s 2.8%.
Note how the annual rate of consumer services price inflation almost always outruns the overall rate of PCE price index inflation. Consumer services are less likely to benefit from productivity improvements compared to tangible consumer goods. Moreover, consumer services are better insulated from international competition than are internationally tradeable consumer goods. Here we are reminded that recent and prospective barriers to imports from emerging market economies imply higher consumer product prices than otherwise.
Though protectionism may have laudable social goals it may not come cheap. Reductions in competitive pressures not only warn of higher prices, they also risk diminutions of product quality.
The annual rate of inflation for the PCE price index excluding food, energy, and housing slowed to 2.1% in February. The last time the annual rate of inflation for the PCE price index excluding food, energy, and housing last slowed to 2.1% was in the spring of 2010.
Regarding the yearly increases for some of the PCE price index’s principal components, fourth-quarter 2023 showed gains of 5.8% for the housing & utilities index and 2.4% for the health care index.
January-February 2024’s 4.7% year-over-year increase by nominal consumer spending included comparably measured yearly percent changes of -1.3% for purchases of consumer durable goods, +1.8% for consumer nondurable goods, and +6.7% for consumer services.
Early 2024’s yearly performance by consumer spending lagged well behind nominal consumer spending’s 5.6% year-on-year advance of Q4-2023 that included annual increases of 3.4% for both consumer durables and nondurable goods, as well as a 6.7% advance by the consumption of consumer services. The marked slowdown by early 2024’s nominal consumer spending complements expectations of a June 12 Fed rate cut.
10.5% surge by outlays at restaurants and hotels led 2023’s nominal consumer spending …
The following table shows recent year-over-year growth rates for nominal consumer spending and its major components. Columns (1) through (12) show annual growth rates for 2023 in descending order. From calendar-years (CY) 2022 to 2023, nominal consumer spending slowed from 11.5% to 6.9%. As shown by consumer spending’s annual growth rates for 2017 through 2019, the attainment of recurring 2% core inflation requires a deceleration by nominal consumer spending growth to a pace not much faster than 5% annually, on average.
Travel, fun, and health care led CY 2023’s annual increases by nominal consumer spending. The personal consumption of food services and lodging soared higher by 10.5% annually in 2023, followed by spending increases of 9.4% for recreation services (Taylor Swift concerts?), 8.0% for health care services, and 7.5% for transportation services.
Looking ahead for 2024, the attainment of slower core price growth will be joined by notable decelerations for the annual growth rates of spending on (i) food services and lodging and (ii) recreation services,
Real consumer spending’s average monthly gain drops from Q4-2023’s pace …
Real consumer spending posted an average monthly increase of 0.3% during 2023's final three months, wherein the average monthly increases were 0.5% for real spending on consumer durables, 0.2% for real spending on consumer nondurable goods, and 0.4% for real spending on consumer services.
By contrast, 2024's first two months showed a drop by real consumer spending's average monthly increase to 0.1%, wherein a rise by real spending on consumer services to 0.5% per month was largely offset by average monthly contractions of -0.8% for real spending on consumer durables and -0.5% for real spending on consumer nondurable goods. Again, this is good news for those looking for a June rate cut.
Consumer spending accounted for 1.51 percentage points of 2023’s 2.5% annual increase by real GDP. Consumer spending’s top performer in terms of the category’s contribution to 2023’s real GDP growth was the 0.59 percentage points of health care spending. Far behind were the contributions to real GDP growth of 0.19 percentage points from restaurants and accommodations and the 0.18 points from purchases of recreational goods and vehicles. The contribution to 2023’s real GDP growth from spending on motor vehicles and parts was 0.14 points.
Lower interest rates require slower growth by wages, salaries, and spending …
February’s 0.8% monthly rise by nominal consumer spending was joined by a 0.3% monthly gain for the PCE price index. In turn, February’s real consumer spending advanced by 0.4% monthly following January’s downwardly revised -0.2% monthly drop. Right now, real consumer spending’s annualized quarterly growth rate might ease from Q4-2023’s upwardly revised 3.3% to 2.3% for 2024’s second quarter. The latter neither strengthens nor weakens the case for a June 12 rate cut.
In terms of yearly growth rates, wage and salary income exhibits a stronger correlation with consumer spending compared to disposable personal income. Wage and salary income’s yearly growth rate sank from Q4-2023’s 6.5% to January-February 2024’s 5.7%. The record suggests the latter is still too fast for a 2% recurring rate of core consumer price inflation. Barring a lasting upturn by labor productivity growth, wage and salary income growth ought to average nothing much faster than 5% for core inflation to average nothing faster than 2%.
Private-sector wage and salary income’s yearly growth rate slowed from Q4-2023’s 6.2% to January-February’s 5.3%. The latter was tantalizingly close to a noninflationary rate of labor remuneration growth. However, the annual growth rate for the wage and salary income of government employees edged up from Q4-2023’s 7.9% to the 8.0% of January-February.
All too often government’s leading role as a primary driver of 2023’s US economy has been overlooked. For one thing, real government spending’s 4.1% annual increase for CY 2023 well outpaced real GDP’s 2.5% rise.
Moreover, real health care spending’s 5.6% annual increase for 2023 towered over the 2.2% rise by total real consumer spending. (Health care spending receives considerable support from Medicare and Medicaid, whose outlays are not found in real government spending.) Finally, CY 2023’s 13.2% lift-off by real business spending on structures was largely the consequence of government subsidies and tax breaks aimed at spurring the construction of facilities that manufacture microchips and green-energy-related products.
To the benefit of economic stability, the year-over-year growth rate for nominal construction spending on manufacturing facilities has slowed from CY 2023’s 71.8% and Q4-2023’s 67.8% to the 34.2% of January-February 2024. Nothing more than CY 2023’s breakneck 71.8% annual surge by construction spending on manufacturing facilities warns of misguided investment decisions on this front.