Economic Update February 2024

Overview

Spoiler Alert – No March interest rate cut by the Fed. The January jobs report delivered a rather stunning surprise. The economy added an impressive 353,000 jobs, almost doubling average forecasts of 185,000, and defying market expectations as well as pushing up Treasury Yields. The unemployment rate remained steady at 3.7%. In addition, average hourly earnings surged by 0.6% in January, partly due to a minimum wage increase in 22 states. This pushed hourly earnings up at a 4.5% pace from a year ago. In December, the annual inflation rate was 3.4% for the 12 months, which represents a slight increase from the previous month's rate of 3.1%. The core inflation rate, which excludes volatile food and energy costs, was reported to be 3.9%. A slight decrease from 4% in November and a trend that is expected to continue through 2024, which should help with future interest rate cuts by the Fed. However, at this point, these cuts are not expected until midyear. Further discussed in the What's next section.

The stock markets continue their positive trends. The Dow Jones gained about 1,000 points month over month, closing at around 38,500. The S&P 500 is working itself towards a new record high and is close to reaching the 5,000 mark for the first time, now sitting at around 4,950. This is another 200-plus points increase over last month. The Nasdaq in a similar fashion is sitting at a new record high at around 15,600, which is a 1,000-point increase since the beginning of the year. All in all, all three markets are sitting or are close to record highs. The 10-year Treasury yield remains volatile, hitting 4.18% mid-month before dropping below 4%. Its most recent increase to over 4% again has come after the very positive jobs report, which indicates that the Fed is under no pressure to cut rates in March.

The average rate for 30-year mortgages has remained in the mid-6% range for the month of January. Over the past month, Oil was moving up towards $80/ barrel but is currently trading again at around $72/ barrel, which is relatively stable month over month. Similar to Oil, gold prices had some volatility but month over month have remained unchanged at around $2,050/ounce. The continued weakening of the US dollar against the Euro, with the EUR/USD exchange rate going beyond 1.07 from 1.09, shows the continued dovish stands of the Federal Reserve vs the European Central Bank, although the ECB left rates unchanged as well.

Jobs Report (January)

The January non-farm payrolls report significantly outperformed expectations, with a substantial increase of 353,000 jobs compared to the anticipated 185,000. This performance not only surpassed consensus forecasts but also included important annual benchmark revisions and updated seasonal factors, providing a more nuanced view of the employment landscape.

The revisions indicated a slightly weaker job growth rate throughout 2022 and into early 2023, with a notable downward adjustment of 188,000 jobs for March 2023. Despite this, the latter half of 2023 saw a more vigorous hiring pace, bolstered by an average monthly upward revision of 27,000 jobs and a significant December adjustment of 117,000 jobs.

Private sector employment also saw robust growth, with 317,000 added jobs, led by the service sector's 289,000 job increase. Significant contributions came from health care and education, professional and business services, and retail trade. The goods-producing sectors and government employment also experienced growth, demonstrating the broad-based nature of job gains.

The household survey introduced new population controls, affecting month-to-month employment and labor force changes, yet the unemployment and participation rates remained stable at 3.7% and 62.5%, respectively. This stability, despite the significant job additions, indicates a balanced labor market.

Wage growth experienced a sharp uptick, with a 0.6% month-on-month increase and a year-on-year growth rate accelerating to 4.5%, marking the fastest pace since September. This acceleration suggests robust demand for labor and potentially increasing inflationary pressures.

Despite the strong employment data, market expectations for a Federal Reserve rate cut in May remained largely unchanged, possibly influenced by recent comments from Fed Chair Powell downplaying the impact of strong economic data.

Existing Home Sales (December)

The December report on existing home sales indicated a slight downturn, with sales declining by 1.0% month-on-month to an annualized rate of 3.78 million units, falling short of the anticipated increase to 3.83 million. This decline was more pronounced in the condo/co-op segment, which saw a 7.3% drop, whereas single-family home sales experienced a more modest decrease of 0.3%. The regional breakdown showed varied performance, with the West experiencing growth, the Northeast remaining stable, and the Midwest and South seeing declines.

The inventory levels held steady, slightly above the previous year's figures, with a 3.7 months' supply at the current sales pace. This represents a slight increase from the 3.5 months' supply noted in December of the prior year. House prices continued to rise, marking a 4.4% increase from the year before and showing a slight month-on-month increase on a seasonally adjusted basis.

Looking at the broader picture, 2023 saw existing home sales reach a 28-year low, largely due to the impact of high financing costs. December's sales figures, which were among the lowest since records began in 1995, mirrored the overall challenging year for the housing market. This comparison to historical lows underscores the significant impact of financing costs and broader economic conditions on home sales.

Despite the downturn, there's cautious optimism that the market may have reached its nadir. The recent decrease in mortgage rates from their peak in late October could incentivize both buyers and sellers to re-enter the market. However, the stabilization of mortgage rates and a cooling labor market might temper any significant recovery in the short term. The expectation is for a gradual improvement in sales moving into 2024, contingent on various economic factors including interest rates and the overall health of the labor market. This cautious outlook reflects the complex interplay between financing costs, economic conditions, and housing market dynamics.

U.S. Personal Income & Spending (December) 

In December, personal income saw a slight increase of 0.3% month-on-month, aligning with market predictions but slightly lower than the 0.4% gain observed in November. When adjusted for inflation and taxes, real personal disposable income grew by 0.1%, indicating a deceleration from November's revised 0.5% increase. This subtle growth in personal income underscores a steady, albeit slow, upward trend in consumer earnings.

Consumer spending experienced a notable acceleration, rising by 0.7% month-on-month, surpassing both the previous month's revised gain of 0.4% and market expectations of a 0.4% increase. This surge in spending was evident across both goods and services, with a 0.9% increase in goods spending and a 0.6% rise in services spending. The most significant contributions to this increase came from sectors such as motor vehicles and parts, prescription drugs, gasoline for goods, financial services, insurance, healthcare, and recreation services.

Inflation metrics showed a mild increase with the headline PCE deflator rising by 0.2% month-on-month, a shift from the previous month's decline. However, the annual inflation rate remained unchanged at 2.6%. The core PCE price deflator, the Federal Reserve's preferred inflation gauge, slightly increased by 0.2% month-on-month but showed a year-on-year deceleration to 2.9% in December from November's 3.2%, marking a continued trend towards lower inflation.

The personal savings rate dipped to 3.7% in December from 4.1% in November, indicating that consumers were drawing on their savings to support increased spending, particularly during the holiday season. This robust consumer spending in the face of various economic headwinds is remarkable, yet it's anticipated that this momentum may slow down as we move into the new year, with spending expected to decelerate to a more sustainable pace.

Given the ongoing downward trend in the core PCE price deflator, now below 3% for the first time since March 2021, and the resilient consumer spending, the Federal Reserve may feel less pressured to cut rates in the immediate future. With inflation still above the Fed's target but moving in the right direction, and consumer spending showing resilience, it's unlikely that we'll see a rate cut before the middle of the year. This cautious approach by the Fed reflects a balancing act between supporting economic growth and ensuring inflation returns to its target level.

Manufacturing Index (January)

The ISM Manufacturing Index in January showed a notable improvement to 49.1, surpassing expectations of 47.2, signaling a potential stabilization in the manufacturing sector despite remaining below the 50 threshold that delineates expansion from contraction. The rise in the index was supported by growth in four industries, an improvement from only one in the previous month, indicating a broadening base of recovery within the sector.

A significant positive development was observed in the new orders sub-index, which surged by 5.5 percentage points to 52.5, marking a return to growth territory and reaching its highest point since May 2022. This break from 16 consecutive months of decline in new orders is a robust sign of reviving demand within the manufacturing sector.

However, challenges remain, particularly in the international market, as evidenced by the deepening contraction in new export orders, which fell by 4.7 percentage points to 45.2. Additionally, the employment index continued to indicate contraction for the fourth consecutive month at 47.1, reflecting ongoing hesitancy in workforce expansion amidst uncertain market conditions.

On a brighter note, the production sub-index slightly increased to 50.4, indicating a marginal return to growth. This change suggests that manufacturers are beginning to ramp up production in response to improved order intake. Despite this positive momentum in production and orders, the backlog of orders persisted in its decline for the 16th consecutive month, standing at 44.7, hinting at challenges in sustaining long-term production levels without a consistent order pipeline.

In terms of costs, the prices paid sub-index experienced a significant jump of 7.7 points to 52.9, indicating the first rise in raw materials prices since April 2023. This increase in input costs could signal growing pressures on margins for manufacturers if not accompanied by corresponding increases in selling prices.

Overall, the January ISM Manufacturing Index presents a nuanced picture of the manufacturing sector, with signs of bottoming out in certain areas but continued challenges in others. The anticipated reduction in interest rates could catalyze further recovery by boosting goods demand and alleviating some of the cost pressures faced by manufacturers. This development, coupled with the improvement in new orders, provides a cautiously optimistic outlook for the manufacturing sector moving forward.

Vehicle sales (January)

U.S. vehicle sales experienced a decline in January, with a 5.6% month-on-month drop to an annualized rate of 15.0 million units, falling short of the expected 15.7 million units. Despite this monthly downturn, unadjusted sales volumes showed a 2.8% increase over the previous year, reaching 1.08 million units. However, the average daily selling rate (DSR) saw a slight decrease from the previous year, marking the first year-on-year decline in sixteen months, which could indicate a cooling in the vehicle market's momentum.

The sales dynamics between different vehicle types showed some variation, with passenger vehicle sales experiencing a modest year-on-year increase of 1.4%, while light-truck sales saw a more significant growth of 3.1%. Light-trucks continued to dominate the market, maintaining an 80% share of total sales, mirroring their market presence from January of the previous year.

Several factors contributed to the drop in light vehicle sales at the year's start. The post-holiday reduction in consumer spending, coupled with the impact of several winter storms, likely dampened sales activity. Additionally, the potential pull-forward effect into December, driven by consumers seeking to capitalize on end-of-year deals amidst ongoing affordability challenges, could have detracted from January's sales figures.

The vehicle market has been grappling with affordability issues following two years of significant price increases driven by supply constraints. In 2023, the average transaction price saw a modest decline of 2.4%, suggesting that demand remained robust and that increased incentive spending was beginning to counterbalance the need for price reductions to entice buyers.

Looking ahead, the outlook for light vehicle sales in 2024 is more optimistic. Factors such as continuous improvements in supply, rising incentives, and real income growth are expected to bolster sales. Moreover, the anticipated introduction of monetary easing, the first since the pandemic's onset, is poised to enhance vehicle affordability further. While these improvements are likely to be gradual, they signal a positive trajectory for the vehicle sales market, offering a more favorable environment for both consumers and manufacturers.

What's Next

Lots to unpack with this new job's report that outpaced projections quite significantly. Right off the bat, January reports are tough to read as there is usually a lot of seasonal hiring in December and November, which would explain the upward revision for that month as well. Either way though, the report came in much stronger than anticipated, and its main effect is that any hopes for a rate cut in March have been crushed. Now going back to last year, I mentioned that rates will be higher for longer, and March would be very early should the Fed decide to do so. With the updated job report, the odds of a rate cut have been reduced from 40% to about 20%. So you say there is a chance? Sure, I am not part of the Fed, so I'm not privy to their conversation other than their statement releases.  At the same time, given where we are in the Economic Cycle of taming inflation, which is still the #1 goal since there does not seem to be a weakness in the labor market, the actual chances are probably zero. 

So, when are rate cuts coming, and how many of them? My best guess is that the Fed is going to be in quadrium pretty soon. The consumer has continued to spend through the Christmas season.  As of February 2024, U.S. consumers have taken on an additional $43 billion in credit card debt during the second quarter of 2024, which is more than triple the average amount since the Great Recession. The total outstanding credit card balances have reached an all-time high of $1.08 trillion. Average Consumer Debt: The average consumer owes currently approximately $7,000 in credit card debt. Credit card interest rates have exceeded 20%, the highest in more than two decades, due to the effects of higher interest rates. The total household debt in the U.S. entering 2024 is at a new high of $17.3 trillion. The largest increase in any category was in credit card debt, which swelled by 16.6% between Q3 2022 and Q3 2023. Furthermore, the savings rate has fallen to a dismal 4%, less than half of where it was two years ago.

There has to be a pullback at some point and it likely will be soon. After all, the US consumer is not the US government. The good news is that wage growth has been good, higher minimum wages have been implemented in various states, and Unions have successfully negotiated new higher compensating packages. But guess what, this positive news is usually followed by layoffs as companies try to compensate for higher salaries by increasing efficiencies, and automation, which equates to layoffs- nothing new, just the standard playbook. With more layoffs coming, the consumer will have to pull back as well. This will start the negative cycle and potentially end up in a recession. 

Whether we will experience the traditional recession indicator of back-to-back negative GDP growth quarters remains uncertain. Government spending has continued unabated, and there is still significant momentum from previously passed spending bills. Over the past two years, state and local government spending has contributed more than twice as much to GDP than historically. If the Federal Reserve were to cut rates multiple times this year or at a rapid pace, it would likely do so without clear evidence of a recession. The more probable scenario is that the Fed will begin cutting rates in the second half of the year, possibly in the June or July meetings, with additional cuts in September, November, and possibly December, depending on economic indicators.

However, there is limited time for substantial rate reductions. If the Fed were to cut rates by 2%, it would signal serious economic challenges, potentially causing further consumer and corporate anxiety. The most likely scenario involves a total reduction of 75 to 100 basis points by year's end. The slow pace of rate cuts implies that corporate and commercial real estate debts will face refinancing at higher rates, which could become a significant issue in 2024. The commercial real estate sector, in particular, may face considerable challenges, with significant implications for the broader economy. There is certainly a scenario, where the commercial sector (office) causes significant issues in the financial markets, leading to bank failures. This coupled with a consumer pullback and a softening of the labor market could lead to much faster interest rate cuts. It would then more look like what happened in 2008, also an election year, but let's stay away from "doomsday" scenarios (for now).

Something to keep in mind, Geo-political issues such as China/Taiwan - Taiwan Strait, Russia/ Ukraine - grain, fertilizer, energy, and Red Sea as well the Straight of Hormuz shipping issues could all negatively affect the supply chain again and cause increased inflation.