Palumbo Pulse July 22nd, 2024: Not So Fast!

The rate cut train was building momentum when a strong 2Q GDP report hit and stopped that train in its tracks. The stock market was already on edge as the early earnings reports, including the tech sector, have either not been up to par, or simply failed to impress. The earnings bar is set very high this quarter and thus far, it appears to have been set too high, sending the market into a small tailspin. The Fed’s favorite inflation measurement, PCE inflation, was reported on Friday morning and came in right on target. This allowed a small relief rally on Friday, but it was still an ugly week.

The initial second quarter GDP estimate came in at 2.8%, higher than all but one Wall Street estimate. The strong report was primarily a function of a rise in personal consumption expenditures and a rise in inventories. Like much of the data we have seen over the last year, this was somewhat baffling. Frankly, it is hard to reconcile relatively strong consumption data when companies from LVMH Moët Hennessy (LVMUY) to McDonald’s (MCD) are reporting that the consumer is taking a step back.

Since the beginning of the rate hike cycle, the Fed has been focused on bringing inflation down with little concern for the economic consequences because the labor market was so strong. With the labor market now beginning to weaken, the Fed now faces a dual risk. Push too little on inflation and risk a re-acceleration, or push too hard and risk a recession. The addition of that recession risk have pushed markets to anticipate rate cuts sooner rather than later. Indeed, this week former Fed official William Dudley called for the first rate cut to be made at the July Fed meeting next week, but this week’s GDP print takes the air out of that balloon, at least for now.

At the risk of repeating some recent comments we’ve made on these pages, the Fed’s work is most difficult at inflection points. With inflation appearing stubborn at 3% and the labor market weakening, the Fed has some tough decisions ahead and where those decisions lead is not clear. While an approaching recession does appear to be in the cards, that doesn’t necessarily mean a recession isn’t on its way. Recessions typically do not make their entry like the opening ceremony at the Olympics; they sneak in the back door.

In June of 2008, the Fed issued its regular Summary of Economic Projections, which is partially shown in the picture below. Note that the GDP growth estimate was raised to a range of 1.0% to 1.6%, from a range of 0.3% to 1.2%, demonstrating a fair bit of optimism from the Fed. Of course, Lehman Brothers collapsed only 3 months later and when looking back, it was determined that the recession had actually started in December 2007.

Whatever happens, happens, but don’t panic about a recession. In many respects, a plain vanilla recession (that is, not a dire, financial crises like we had in 2008) could be a welcome outcome because it could firmly anchor inflation at low levels and allow some of the excesses of the COVID era to be corrected. The good news is that recessions are followed by recoveries. A modest recession right now could set the U.S. on firmer footing to a more durable recovery that is not dependent on the deficit spending and easy monetary policy of the past 10 years. Sometimes, you have to take a step or two backward before moving forward again.

Have a great week!

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 The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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