Slower inflation was supposed to be a sign that the economy was cooling, all part of the Federal Reserve’s plan for higher interest rates to restore balance to the economy. For a while, things looked on track. But since the middle of January there’s an argument that economic activity is picking up again, despite monetary policy being tighter than at any point in years.
The catalyst is the growing confidence among consumers and businesses alike, ironically driven by the slowdown in inflation the Fed has been working to engineer. Monetary policy remains tight — look no further than the struggles in the automobile and commercial property sectors or affordability challenges for homebuyers — but, for now, there are too many industries showing signs of resilience or acceleration to believe that the central bank’s stance will cause the labor market or economy to unravel.
Frequent readers of mine will note that this is a walk-back of a bias I’ve had for the past few months. I started worrying about a labor-market slump in early November as the unemployment rate rose and worker income growth slowed. Earlier this month, I described the recovery in some cyclical parts of the economy as akin to a “dead cat bounce” that would eventually be swamped by high interest rates; it’s not unreasonable for something like existing home sales to climb when transactions were at their lowest level since 2010.
But over the past couple of weeks, we’ve gotten more evidence, particularly from corporate earnings updates, with company executives reporting resilience or strength in their businesses and showing more confidence in the future.
Perhaps nobody summed up the mood around consumers better than Walmart Inc. Chief Financial Officer John David Rainey when he said: “There was largely a consensus that we were going to enter a recession in the last year. Fortunately, we avoided that. And so, I think overall, we feel a little better about the health of the economy right now.”
After slashing inventories by in excess of 15% on a year-over-year basis — more than ever before — Home Depot Inc. Chief Executive Officer Ted Decker said, “We feel very good about our inventory position heading into 2024,” a sign that the worst is over for factories that have spent more than a year complaining about weak new order growth.
Luxury homebuilder Toll Brothers Inc. said foot traffic in model homes this past week was the highest it’s been since February 2022, showing that even mortgage rates above 7% are workable for a certain segment of buyers.
And Nvidia Corp. reaffirmed its position as the darling of the stock market and confidence in the artificial-intelligence boom when it once again smashed earnings expectations.
These four companies give us a pretty good insight into the state of the consumer, goods economy, housing market and spending on the key growth area of technology — collectively, the lion’s share of economic activity. All reported varying degrees of rising confidence, whether due to working down inventory levels and making it through a challenging 2023, or flat-out optimism about 2024.
Torsten Slok, the chief economist at Apollo Global Management Inc., noted that the uptick in confidence among consumers began when the Fed pivoted away from a bias toward raising rates in mid-December. Financial markets had begun anticipating the turn at the end of October, and we’re now hearing about it from CEOs as they talk about the state of their businesses and their plans for 2024.
This poses a conundrum for Fed officials as they think about the timing and extent of policy easing this year. They believe monetary policy is restrictive and becomes more so with every passing month of decelerating inflation. At the same time, markets, consumers and businesses take relief on the pricing front to mean that the odds of a recession have fallen, and rate cuts are coming, leading them to bid up stocks, spend more money, and potentially shift from a mindset of cost-cutting to one of expansion.
One nice dynamic for the Fed is that if they end up delaying rate cuts and disappointing market expectations, it’s likely going to be due to overly fast economic growth and the potential for faster inflation rather than the overly hot actual inflation data received in 2022 and 2023. Once economic growth slows, as they continue to forecast, policymakers have plenty of room to cut rates, providing an immediate boost to rate-sensitive parts of the economy such as housing and autos.
It’s debatable how much rising confidence can boost economic growth at a time when inflation-adjusted policy rates are much higher than they’ve been over the past 15 years. It’s entirely possible that a recovery in depressed cyclical areas of the economy and improved vibes will run into the hard reality of borrowing costs that remain at generational highs. Maybe a run-of-the-mill stock market selloff dents confidence and we get the policy easing that markets continue to anticipate. But if sentiment continues to recover, faster-than-anticipated growth rather than interest-rate cuts might turn out to be the story of 2024.
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