Richard Drury
Continued strength means a June rate cut seems unlikely
The US economy continues to demonstrate remarkable resilience in the face of high borrowing costs, tight credit conditions and an unfavorable external environment. He appears to be on track grow at an annualized rate of 2.5% in the first quarter. We already know that 829,000 jobs were created in the first three months of the year. With inflation still closer to 4% than the 2% target – and Wednesday’s figures were a surprise – we must admit that the likelihood of an imminent easing of Federal Reserve policy seems more remote than previously thought.
Financial markets are now pricing in only a 5 basis point easing for the June FOMC meeting, implying a roughly 20% chance of a 25 basis point rate cut. For the Fed to keep its promises, we believe we will have to the next two figures for core inflation will be 0.2% month-on-month or below instead of 0.4% and a sharp slowdown in payroll growth of around 250,000 per month to well below 150,000. It’s possible, but we’re not sure. We now believe that a starting point for Fed easing in the third quarter, either in July or, more likely, in September, appears to be a more credible move than in June.
Business surveys suggest economy is weaker than official data reports
But surveys still suggest a sharp slowdown is coming
That said, the divergence between the strong official activity data and the much weaker survey data is striking. The ISM indices are at historically consistent levels with economic growth of 0.5% year-on-year – significantly lower than the 3% year-on-year GDP rate recorded in the last quarter of 2023. The employment components of these indices are in contraction territory for several months. .
Arguably the most reliable labor market indicator in recent times, the National Federation of Independent Business’ Hiring Intentions Series, suggests that payroll growth will slow significantly over the next three to four month to reach perhaps less than 50,000 per month.
Significant interest rate cuts remain our priority
At the same time, manufacturing orders are doing nothing, small business optimism is at a 12-year low, real household disposable incomes are stagnating and savings accumulated during the pandemic are largely exhausted, according to the calculations of the San Francisco Fed. We strongly suspect a slowdown is coming, but this may not be evident in official data until later in the year. Persistent inflation further undermines the prospect of short-term rate cuts, so our previous call for a 125 basis point cut this year seems overblown. We now expect easing of 75 basis points in 2024.
We expect inflation to converge towards 2%, as slowing economic activity and moderate growth in labor costs will help ease price pressures. This should allow the Fed to cut rates further in the first half of next year, bringing the target rate to 3.5%. For the Fed to continue cutting interest rates would likely require a systemic shock, most likely through a resurgence of small banks’ financial fears triggered by losses in commercial real estate or consumer lending .
