The Federal Reserve may be tempted to take a victory lap in the fight against inflation today and offer hints that it could be at the end of the rate hiking cycle. Headline CPI is down to 3.0% y/y from a peak of 9.1%.
The Fed target is still a full percentage point away but 3% inflation certainly isn’t a crisis, especially in a positive-growth environment.
The problem is that inflation could re-accelerate. For much of the year, US consumers and businesses have been restraining spending in anticipation of a recession. If you remember back to the turn of the year, virtually every US economist was calling for a recession and the only debate was whether on the severity (though some saw it correctly).
Manufacturing leading indicators were often cited with many economists failing to fully grasp the whipsaw effect from the pandemic and the extent of pent up savings and 30-year fixed rates for the services sector.
At times we overestimate how much effect the front page of the Wall Street Journal has on main street, so all the talk of recession may not have weighed too heavily on consumers. But it did on businesses, which went into this year with low capex commitments and plans to draw down on inventories.
That kind of psychology goes a long way towards doing the Fed’s work for it. The aim of higher rates is to get consumers to spend less but if they do it before the rate hikes bite, that’s even better.
The problem this time is that the rate hikes haven’t bit. Employment remains extremely strong and demand in the services sector has held at high levels. Perhaps that comes later but the risk is that it doesn’t. In fact, the risk is that consumers and businesses tune out high rates and spending picks up.
Note the latest uptick in US consumer confidence:
Along with potential upside from the consumer, I see two positive sources of strength in 2024 that were both drags in 2023:
1) Manufacturing
2) Housing
In the latest S&P Global manufacturing survey, the expectations component hit the highest since April 2022 and that pattern has played out in a number of regional surveys. Manufacturing has undoubtedly been in recession but there are green shoots regarding a turnaround.
Home builders also dialed back plans dramatically for 2023 in anticipation of high rates but US home prices held up better than almost anyone (ahem) thought. Now builders are finding that rate buy-downs are a powerful tonic and pushing buyers towards new homes. If plans to build pick up in 2024, and I think that’s a strong possibility, that could be a big tailwind for the US economy.
The x-factor in all this is commodities but manufacturing and construction are major drivers of commodity prices. However all these factors don’t line up the same outside of the US, so even if commodity demand in America rises, falls in Europe and elsewhere could prevent commodity inflation, saving the Fed a headache.
For now though, Fed Chair Jerome Powell should be mindful of the dwindling recessionary mindset and maintain optionality to hike again in September or November. For me, the risks around this appearance are skewed towards the hawkish side, which is negative for stocks and positive for the US dollar.
More:
Here is the path to a 6% Fed funds rate — and beyond
This article was written by Adam Button at www.forexlive.com. Source