Stick a fork in it
As the economy slows across the board, the Fed is done hiking rates.
Bottom Line
The recent upward revision of third quarter GDP growth may have provided investors with a false sense of security. The Commerce Department’s seemingly impressive increase in the economy’s annualized growth from 4.9% to 5.2% hides a dip in personal consumption. This critical category, which accounts for 70% of the overall contribution to GDP, actually suffered from the revision, declining from an initial growth rate of 4.0% to 3.6%. It was inventory accumulation and federal government nondefense spending that increased, not consumer activities.
To be sure, the upward revision of corporate spending on structures and residential construction are higher quality positives. But the headline increase does not support the notion that U.S. economy is both strong and accelerating. In fact, the cumulative weight of the Federal Reserve’s policy tightening over the past 20 months is finally starting to bite. We think this will usher in materially slower growth over the next few quarters. We’re still expecting a soft landing, but the runway remains rocky.
Labor market is slowing Nonfarm payrolls rose by a weaker-than-expected 150,000 jobs in October, marking the lowest monthly gain since June. Previously reported August and September gains were revised down by a combined 101,000 jobs, so adjusted payroll growth of only 49,000 was the weakest since December 2020. Household employment lost 348,000 workers, its worst month since April 2020. Also in October, the unemployment rate rose a tick to a 22-month high of 3.9% from April’s 53-year low of 3.4%. This change potentially triggers the so-called “Sahm Rule,” which posits that a recession starts when the 3-month moving average of the unemployment rate rises by 0.50% or more within a 12-month period.
Blue Christmas? Although spending on services remains relatively firm, Back-to-School (BTS) spending (June through September) rose only 2.8% year-over-year (y/y), compared with a robust 9.7% gain in 2022. Easter and Passover “Marpril” spending (March and April) rose a tepid 1.7% for 2023 versus 8.6% for 2022. The Christmas shopping season (from October through January) just got rolling, but October results rose only a disappointing 2.5%, compared with a 7.1% gain in 2022. These three retail seasons share a 73% positive correlation over the past 30 years. Business and consumer confidence have softened in recent months, with excess savings dwindling and savings rates increasing.
Recent housing strength likely to reverse Pending existing U.S. home sales fell to their lowest level on record in October 2023, largely due to the spike in mortgage rates, elevated prices, negative real wage gains and a dearth of inventory. Existing home sales (which account for about 85% of total home sales) declined to a 13-year low of 3.79 million annualized units in October, down by 40% from a 21-month high of 6.36 million annualized units in November 2021. From a strong 56 in July 2023, the Housing Market Index has plunged to 34 in November.
Inflation slowing Nominal CPI peaked at 9.1% y/y in June 2022 and fell sharply to 3.2% in October 2023. The core PCE (the Fed’s preferred measure of inflation) peaked at 5.6% in February 2022 and has declined to 3.5% in October 2023. The Fed’s target remains at 2%, a level the central bank hopes to achieve by year-end 2026, according to its Summary of Economic Projections (SEP) published in September. But given this solid improvement in the pace of inflation in recent months, we could see the Fed pull its target forward into 2025 when they update the SEP in two weeks.
Fed’s done Policymakers skipped rate hikes on June 14, September 20 and November 1, sandwiching what now appears to be their last quarter-point hike on July 26. Historically, this is the point in the cycle at which they take a higher-for-longer pause. With the fed funds range of 5.25-5.50%, the upper band is now above October’s 3.2% headline CPI. That tells us they have ended hiking rates this cycle. We do not expect the first rate cut before the second half of 2024, however. The timing is uncertain, as the Fed typically does not adjust policy close to a presidential election.
We’re still bullish on stocks The S&P 500 has rallied 12% over the past five weeks, from an oversold 4,100 on October 27, and it is rapidly approaching our year-end target of 4,600. Because stocks tend to rip on Fed pauses, we expect the S&P to rise in choppy fashion throughout 2024 to reach our full-year target of 5,000. We anticipate the rally to broaden, with domestic value, small caps and international stocks playing catch-up, while the growth and technology stocks trim their recent froth.
Tweaking our estimates for growth and inflation The liquidity, equity, and fixed-income investment professionals who comprise Federated Hermes’s macroeconomic policy committee met yesterday to discuss the Fed’s monetary policy tightening and the impact it’s had on the economy:
- The Commerce Dept. revised third quarter 2023 GDP growth from 4.9% to 5.2%, but the quality of that revision was poor, as personal consumption growth declined from 4.0% to 3.6%, while government spending and inventory restocking both rose.
- Spending on services remains relatively strong (think “revenge travel”), offsetting slower Christmas spending on goods. So we raised our fourth quarter 2023 growth estimate from 1.3% to 1.5%; Blue-Chip consensus raised its from 0.7% to 0.9% (within a range of -0.1% to 1.6%); The Atlanta Fed’s GDPNow's estimate is 2.1%.
- We raised our full-year 2023 growth forecast from 2.1% to 2.5%; Blue-Chip consensus increased its from 2.2% to 2.4% (within a range of 2.2% to 2.4%).
- We lowered our year-end 2023 estimate for core CPI inflation from 3.8% to 3.6%, while the Blue Chip left its unchanged at 4.1% (within a range of 3.9% to 4.2%). That compares with actual core CPI inflation of 4.0% in October 2023, down from a 40-year high of 6.6% in September 2022.
- We also reduced our year-end 2023 forecast for core PCE inflation from 3.5% to 3.3%, while the Blue Chip left its unchanged at 3.8% (within a range of 3.5% to 4.0%). Actual core PCE inflation was 3.5% in October 2023, down from a 39-year high of 5.6% in February 2022.
- Anticipating a bit of a Christmas spending hangover, we reduced our estimate for first quarter 2024 GDP growth from 1.0% to 0.9%; Blue-Chip consensus doubled its estimate from 0.2% to 0.4% (within a range of -1.0% to 1.4%).
- We left our projection for second quarter 2024 growth unchanged at 0.9%; Blue-Chip consensus reduced its from 0.5% to 0.4% (within a range of -1.1% to 1.5%).
- We left our estimate for third quarter 2024 growth unchanged at 1.2%; Blue-Chip consensus reduced its from 1.2% to 0.9% (within a range of -0.9% to 2.1%).
- We left our estimate for fourth quarter 2024 GDP growth unchanged at 1.5%. The Blue-Chip consensus ticked its estimate down from 1.6% to 1.5% (within a range of 0.6% to 2.3%).
- As a result, we increased our full-year 2024 growth estimate from 1.3% to 1.7%; Blue-Chip consensus raised its from 1.1% to 1.2% (within a range of 0.7% to 1.8%).
- We reduced our year-end 2024 forecast for core CPI inflation from 3.0% to 2.7%, while the Blue Chip left its unchanged at 2.7% (within a range of 2.3% to 3.1%). We also reduced our estimate for core PCE inflation from 2.7% to 2.4%, while the Blue Chip left its unchanged at 2.4% (within a range of 2.1% to 2.8%).