It is very difficult for the Federal Reserve (Fed) to have any conviction at this time on the timing of interest rate moves when all the numbers on the economy, with probably the exception of soft data but especially consumer confidence and sentiment soft data, are still pointing to a strong economic backdrop.
Furthermore, what is happening in the economy is understandable because the tariff shock has been such that it has changed the behavior of economic actors, i.e., businesses as well as consumers. That is, even though American consumers are sending stress signals in responding to confidence and sentiment surveys, they have been preparing for battle any way, sort to speak, by buying all of those goods they can buy ahead of the increase in the price due to the effects of the tariffs. This was not reflected during the first quarter of the year, as real personal consumption expenditures (PCE) grew by only 1.8%, but it did happen during the fourth quarter of last year. PCE grew at a strong 4.0% rate during the last quarter of last year, with durable goods consumption growing at a strong 6.2% rate, motorized by purchases of motor vehicles and parts. This component of PCE grew by an impressive 19.7% during the last quarter of last year while falling by 11.1% during the first quarter of this year, quarter-over-quarter, annualized.
Of course, this is not something everybody can do at any point in time. Although firms front loaded imports during the first quarter of the year, as shown in the real GDP report released at the end of April, and consumers did so during the last quarters of last year, only those consumers at the higher income levels and/or those with access to credit could change their behavior, especially for the consumption of durable goods like cars or other large items. Consumers that do not have the wherewithal to do this will probably have to postpone consumption of some of these big ticket items.
For the economy as a whole, the tariff shock is an event that distorts normal behavior in the economy. That is, the front loading of imports during the first quarter of the year and the step up in auto purchases and other durable goods purchases during the fourth quarter of last year changes the typical behavior of economic actors and can put pressure on economic growth during the rest of the year. This is the reason why we have a relatively stronger second quarter of the year and then a weakening of economic activity in the following quarters.
This is also the reason why the Fed has chosen a policy path of “wait and see” because they still don’t know potential effects on inflation and the overall economy. For now, they said this week that the risks for employment and inflation have increased but will not commit to acting until they have a better sense of the actual impact. That is, the Fed is not going to reduce the federal funds rate at a time when inflation expectations are on the move, and everybody is expecting the rate of inflation to start to move higher. However, if the employment situation starts to deteriorate more than what we are expecting today, then the Fed will probably move and start lowering rates faster. But they are not going to move preemptively as they would have done if inflation had been a hovering about the 2.0% target for a long time, as it was the case for the period before the pandemic.
Changes to our forecast
At this time, we are estimating that the U.S. economy will avoid a “technical recession” but we are keeping our probability of recession at 50% just because it is difficult to know how the ongoing uncertainty about tariffs is going to evolve. At the same time, the acceleration of inflation will depend how high the tariffs are going to be, how efficient companies are at substituting away from Chinese goods, and when these price increases are going to appear in the statistics. For now, we expect inflation to start accelerating at the end of the first half of the year and during the second half of the year.
Thus, we are changing our estimate for the first rate cut from June to July, but are still leaving three rate cuts before the end of the year.
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Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.
Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.
Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.
The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.
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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.
Employment cost Index: The Employment Cost Index (ECI) measures the change in the hourly labor cost to employers over time. The ECI uses a fixed “basket” of labor to produce a pure cost change, free from the effects of workers moving between occupations and industries and includes both the cost of wages and salaries and the cost of benefits.
US Dollar Index: The US Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the
U.S. dollar gains "strength" when compared to other currencies.
Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).
ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.
Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households.
Producer Price Index: A producer price index(PPI) is a price index that measures the average changes in prices received by domestic producers for their output.
Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.
The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.
Conference Board Coincident Economic Index: The Composite Index of Coincident Indicators is an index published by the Conference Board that provides a broad-based measurement of current economic conditions, helping economists, investors, and public policymakers to determine which phase of the business cycle the economy is currently experiencing.
Conference Board Lagging Economic Index: The Composite Index of Lagging Indicators is an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.
New Export Index: The PMI New export orders index allows us to track international demand for a country's goods and services on a timely, monthly, basis.
Gold is subject to the special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated.
The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.
Source: FactSet, data as of 12/6/2024
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