June 30, 2024

       As summertime temperatures heat up, some sectors of the economy and inflation appear to be cooling down. Despite May’s surprisingly strong payroll gains, some cracks are starting to show up in the labor market.  April’s job openings fell to their lowest level in three years, the unemployment rate set a 28-month high and the 4-week moving average of initial jobless claims have started moving upward.  Retail spending is following suit as April and May’s retail sales showed a notable downshift.  The housing market is sagging and the manufacturing sector is struggling as high interest rates weigh on business investment and inventories.

     Signs of moderation in spending and hiring suggest supply and demand are coming into better balance and may ease inflation pressures.  Weaker gains in the Consumer Price Index (CPI) in April and May are a step in the right direction.  May’s core CPI came in well below expectations, printing +0.163%, the lowest monthly gain since August 2021.  Producer Price Index (PPI) also surprised to the downside.  The Fed’s favorite inflation gauge, the core PCE Deflator, registered its smallest monthly increase (+0.086%) since 2020, dropping the year-over-year change to 2.6% in May from 2.8% in April. Many of the underlying details of the reports were encouraging for the inflation outlook, and the threat of price re-acceleration due to strong economic activity has diminished to some degree.

     At the May 31 - June 1 Federal Open Market Committee (FOMC) meeting, inflation was still characterized as “elevated.” Though the price data and the outlook were encouraging, the FOMC clearly needs several more benign prints before a consensus emerges that a reduction in the fed funds rate is warranted. For the seventh straight meeting, the FOMC unanimously decided to hold its benchmark rate steady in a range of 5.25% to 5.50%. With a high degree of uncertainty regarding the economic outlook, officials are wary of easing too much, too soon, and squandering gains in bringing down inflation. They also do not want to leave rates at restrictive levels too long and produce a more severe downturn in the economy.

     The FOMC feels it can be patient and take time to gain greater confidence that inflation is on a sustainable path to its 2% goal.  With that, the committee dialed back their expectations for interest-rate cuts this year.  The median projection for the fed funds rate at year-end was raised by 50 basis points to 5.125% from the 4.625% shown in the March projections, implying only one 25 basis point cut before the end of the year.  Still, the distribution of members’ projections was toward more easing, with eight participants expecting two cuts, seven projecting one cut and only four expecting rates to remain unchanged for the rest of the year.  Incoming data will be the determining factor, barring an unexpected event or geo-political shock. The risk of the latter continuing to  elevate. And, Fed Chairman Powell, in his post-meeting press conference hinted that substantial labor market weakness could lead to an earlier rate cut.