Macro musings: It’s starting
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Article Type
Insights
Topic
Macro
Published
December 04, 2023
Read time
5 mins
Author
Frank Rybinski, CFA
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Pockets of contraction are emerging in US economic activity. Specifically, in the November Beige Book, where half of the 12 Fed regions saw outright economic contraction in the period between October 7 and Nov 17. There was also a huge change in language from prior Beige Books, which had noted moderate and modest growth. That tone was echoed by the November Institute for Supply Management (ISM) business survey, which showed the manufacturing space contracting for the 13th straight month. The week also saw a marked change in the tone toward labor. For the first time this cycle, both the Beige Book and the ISM noted that employers were comfortable reducing headcounts and took more action to do so. This was echoed in the Conference Board surveys labor differential. Well get more data points on this topic with the November payroll reports release on Friday, but it appears change is afoot from the labor-hoarding mentality of not too long ago.Higher financing costs are starting to work their way through. For the first time this cycle, two regions in the Beige Book cited the increase cost of debt as an impediment to business growth. The speed with which this permeates the broader economy will be a key to the macro equation in 2024. Exhibit 1: Financial conditions impulse on growth: Baseline 3-year lookback (% change)Sources: Federal Reserve Board, Haver Analytics. Data as of October 31, 2023.Our view The comments in the Beige Book were quite pivotal and underscore a key relationship: The longer the Fed has to stay on hold at these restrictive levels, the more likely the negative effects accelerate in a non-linear fashion. This is the crux of the high-wire act the Fed is trying to pull off (i.e., Can it slow demand just enough to reduce the inflationary pressure, but not so much that it causes a contraction in output that stimulates a negative labor response). The economys last stand is the title of our forthcoming 2024 Macro Economic Outlook where we essentially frame the issue as: Can the economy hold up until the rate-cutting cavalry arrives? Our base case says no, as we see a mild economic contraction occurring during the first half of 2024 and contributing to a Federal Reserve rate cut in the third quarter of that year (while acknowledging that a June rate cut is a real possibility). Conversely, the consensus has massively reduced its GDP forecast for the first half of 2024 from about +1.5% earlier this year to an anemic +0.4% and +0.3% for first quarter and second quarter of 2024, respectively. Within that context the consensus has the Fed cutting rates in the second quarter of 2024, while the futures market is pricing about a two-thirds chance of a cut as early as March 2024. Reconciliation We now seem to be converging on the first half of 2024 as the trough, albeit with a slight difference in magnitude. At this point, Id give our base case two-thirds odds and the consensus case one-third odds. Id be remiss if I didnt mention the inflation data that was released last week: The personal consumption expenditures deflator, and all its derivatives, echoed the consumer price index data released a few weeks ago, which showed disinflationary trends taking hold and slowly broadening. The market is basically pricing in that these trends will accelerate and clear the decks for a Fed interest-rate cut in March. Thats certainly possible, but we think premature at this point unless unemployment were to begin a step-change higher very soon. Exhibit 2: Inflation - Slice and Dice (As of October 2023)% of Index Month-over-monthchange Month-over-monthannualized rate 3-month annualized rate6-month annualized rateYear-over-year change CPI-U100%0.04%0.5%4.4%3.2%3.2%CPI-U: Core80%0.23%2.8%3.0%4.0%4.0%CPI-U: Core, ex-Shelter45%0.14%1.7%1.3%2.4%2.0%CPI-U: Core, ex-Shelter and Used Autos42%0.20%2.5%2.5%2.3%2.8%CPI-U: Core Services, ex-Shelter27%0.30%3.6%4.8%1.9%3.0%PCE100%0.05%0.6%3.3%2.8%3.0%PCE - Core88%0.16%2.0%2.2%3.3%3.5%PCE - Core Services, ex-Housing-0.15%1.8%3.1%3.6%3.9%Dallas Trimmed Mean PCE-0.22%2.7%-2.9%3.6%Cleveland Trimmed Mean PCE-0.26%3.2%--4.2%San Fran Cyclical PCE Inflation--3.2%--6.1%San Fran Acyclical PCE Inflation--1.3%--2.0%Source: Haver Analytics

Author

Frank Rybinski, CFA
Head of Macro Strategy

Frank Rybinski, CFA, is head of macro strategy responsible for guiding the firm’s global macroeconomic view as it pertains to tactical and strategic asset allocation.

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