The Economy Looks Too Robust for the Federal Reserve to Cut Rates
Leading indicators point at continued strength--justifying our interest rate outlook, and the unlikelihood of rate cuts in March
First, retail sales were strong at .6%, slightly beating consensus estimates of .4% expansion. Consumers felt comfortable enough in their jobs and economic prospects to spend. This is critical, as consumer spending constitutes 70% of the US economy.
Business inventories came in at expectations with a small .1% decline. If the economy is struggling, you tend to see build-up in these figures. Looks like businesses don't have working capital tied up in inventory.
Capacity Utilization continues to trend slightly downward. This is typical in late economic expansions. The rate of descent is moderating, so look for conditions to stabilize. We often see inflation pressures rise at utilization rates above 80%. Confirming our other indicators, inflation continues to moderate. The war on Inflation is won.
Industrial Production was flat against a consensus for slight contraction. The current trend indicates that the (very) mild manufacturing recession maybe at an end.
Prices for imports were unchanged, meaning consumers and businesses weren't under pressure from a falling currency or increasing input costs. It is likely that some of the deflationary price pressures currently being experienced in China are now being imported by the United States.
Meanwhile, Export Prices were unchanged, after having recently fallen. This is reflective of exchange rate effects.
Building Permits were up slightly as homebuilders expressed confidence in lower future mortgage rates and an unmitigated need for more square footage.
Despite the rise in Permits, Starts were slightly down, though down less than was expected.
In a sign of continued labor market strength, Initial Claims for Unemployment Benefits were 187,000, quite a bit better than the 207,000 that were forecast. Corporations don't seem to feel the need to trim their workforce to meet profitability goals.
Lastly, the Philadelphia Fed Manufacturing Index, a diffusion index that reflects the outlook for businesses in the manufacturing industry in the Philadelphia district showed meager improvement. This measure is underwater, reflecting a better, but still sour mood about the prospects for manufactures. Current New Orders and Current Shipments were both higher, employment was steady, and price indexes registered increases. COVID-19 may have produced a secular shift in consumption habits from goods to services, and this is one area where we would see that dynamic play out.
The US economy seems to be handling higher rates pretty well. Although we believe that rate cuts will likely come in 2024, we don't believe that we will see any in March. The Federal Reserve's Waller and Bostic have both come out this week stating that market expectations of imminent rate cuts are overdone. Consequently, yields are rising and financial conditions are tightening.
Europe Moves Toward Rate Cuts
Like the United States, the Eurozone continues to see lower inflation. Core inflation came in at 3.4% in December, continuing its gradual fall. Headline inflation was higher in December due to one-time effects that had been anticipated; nonetheless, the market jumped at the data. The real story behind the media frenzy is that inflation in the EU, like inflation in the US and China, continues to trend downward.
That rate cuts are likelier in the EU than in the US is primarily down to not just the level of inflation, but also to how poorly GDP in the EU is registering. Europe is certainly known for its low levels of growth, but it is also certainly capable of more. As inflation continues to improve, the ECB should be ready and willing to provide monetary policy accommodation.