Get comfy. We're going to be here awhile.
The Federal Reserve Open Market Committee left short-term interest rates unchanged at 5.25 - 5.5% yesterday, where they've been since the end of July 2023, a level which Federal Reserve Chair Powell described as "restrictive". While rates are certainly higher than we've seen since the mid-2000's when compared to the last 30 years, they are still substantially off their highs.
In his comments, he also stated that recent readings in the Personal Consumption Expenditures (PCE), Core PCE (excluding food and energy) and Supercore (excluding food, energy and shelter) PCE price indexes had given the Fed pause as to their current progress against inflation, but not enough to warrant additional increases in interest rates. Headline PCE came in at 2.7%, Core PCE at 2.8%, and Supercore at 2.2%. While higher than the Fed's 2% inflation target, he stated that inflation below 3%, while still too high, represented remarkable progress from 2023, when headline PCE crested at 7.1%.
As we mentioned last week, price echoes that are the result of COVID's negative supply shock reverberate even now, still so many years after the world opened back up after being shuttered for over a year. The economy and forecasting are still trying to get back to normal, but these things take time to get worked out of the machine--but that they will eventually do so with the passage of time seems overwhelmingly likely.
Growth for the first quarter was measured at 1.6%, a number that far undershot the market's anticipation of 2.5% growth. It was a disappointing figure not only because it came in below expectation, but also because it portended weakness in the economy in the face of higher inflation. Without taking time for reflection, the financial media reached into the Bogeyman's bag of nightmare words and picked out the scariest: stagflation. When asked about the prospect of high inflation and low growth, Powell appropriately remarked that he was unfortunately old enough to remember Stagflation, and that it entailed inflation rates in the teens, low growth, and high unemployment. Currently, inflation is below 3%, growth excluding imports is 3.1%, and unemployment is below 4%. That's a very healthy economy, not one that is undergoing stagnation and inflation.
The futures markets have been working overtime discounting the changes in expectations over the past month, and now estimate that the likelihood of a cut of .25% in interest rates in July is only 25%. A cut by September is now priced in to be a 50/50 proposition, and a cut by December to have odds in favor of 4 in 5.
Real Final Demand as well as Business Fixed Investment, two indicators that reliably point in the direction that the economy is headed both show the same thing: demand is withstanding the current level of interest rates, much as they had in the late 90's when we last saw inflation, rates, and productivity at the same levels we see today.
Neither inflation nor growth are being crushed beneath the weight of too-onerous interest rates. Expect more of the same until something changes in the labor market--which continues to show signs of rude health, and which we expect to continue its expansion this Friday when we receive Non-farm Payrolls data for April.