A relatively quiet news week, at least as far as the markets are concerned. There were a couple notable earnings misses, but three topics seemed to matter at the macro level: recession risks seem to be abating, inflation continues to cool, and the Fed is nearing the end of their tightening cycle.
Nothing in the data this week contradicted this narrative. The key report was the first estimate on fourth quarter economic (GDP) growth. Growth came in at + 2.9% on annualized basis between September and December. This was slightly higher than economists’ forecasts of +2.6%, but a slowdown from +3.2% in the third quarter.
There’s always something for everyone in these reports, but the details paint a slower growth picture than the headline number. Critically, roughly half of all the growth in the quarter came from inventory restocking. This is generally viewed as a one-time type of thing – companies usually don’t continue to boost inventory levels over multiple quarters. This would imply that growth in the current quarter softened materially.
To quote Goldman:
“Real GDP rose 2.9% annualized in the fourth quarter, three tenths above consensus. The details were much softer however, as inventories contributed over half of the increase and will likely weigh on Q1 growth. Additionally, both consumption and business fixed investment growth slowed by more than we expected.”
The chart below captures this idea. Basically, housing stunk and fixed investment in plants and equipment dipped materially.
On the positive side, consumer spending continued to grow at a 2+% type of rate, underscoring that consumers remain willing and able to spend. From a market perspective, this was a decent report. Not too hot where investors have to worry about more dramatic Fed hikes, but not too cold that a recession looks like it is imminent.
Inflation and the Fed Pause
Probably the bigger number that came out this week was the so-called Personal Consumption Expenditures (PCE) inflation statistic. It showed that the cost of U.S. goods and services rose a scant +0.1% in December in yet another sign inflation is cooling off. On a year-over-year basis, inflation was up +5% in December. If you strip out food and energy prices, annualized inflation was +4.4% year-over-year (chart below).
This feeds into the narrative that inflationary pressures have peaked and are now trending lower.
Core inflation (based on this measure at least) also means that the Fed Funds rate is now higher than inflation. Economists would say that real rates are now positive (real rates = rates adjusted for inflation). As you can see below, the difference between the Fed Funds rate and inflation has been deeply negative ever since the COVID crisis.
This was by design of course. When rates are below inflation the incentive to borrow and spend or invest is pretty high. But that has all changed. It doesn’t mean the Fed is done, but it does play into the idea that the Fed probably has rates at neutral now and that they can start to back off.
The next Fed announcement will come on Wednesday. A quarter-point hike is all but a done deal.
The more interesting thing to watch will be whether the Fed sets up for another hike in March, or leaves open the possibility of a pause.
(Other) Charts We Found Interesting
- From Michael Cembalest at J.P. Morgan – “The balance between entitlement spending and non-defense discretionary spending started out at 1.0x when Medicare and Medicaid systems were created in the late 1960’s. That ratio is now almost 3.0x and will rise to 4.0x in a few years. By 2032, entitlement payments plus interest are expected to consume all Federal revenue collection on a permanent basis, with little left for discretionary spending.”
- A history of government shutdowns. Not particularly unusual.
- Another chart arguing that monetary policy is unusually tight.
- We are seeing more and more headlines about layoffs in the tech sector. This puts things in a bit of context (wow, Amazon!!!).
- And despite the layoffs in tech, weekly unemployment claims ticked lower again last week.
- For the first time ever, there are now more jobs in Florida than in New York.
- Mortgage rates are down about 1% from the high.
- Whoever put this together really nailed it.
Have a good weekend.
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