December 1, 2023

     The U.S. economy ran hot in the third quarter, but recent data gives evidence of cooling.  This isn’t surprising as a global slowdown is under way.  U.S labor indicators showed signs of loosening with payroll growth slowing, the unemployment rate rising and claims for unemployment benefits generally trending higher.  Consumer spending has moderated as a worsening economic outlook weighed on consumer sentiment.  According to the Institute for Supply Management (ISM) both the manufacturing and service sectors lost momentum.  The economy may be slowing, but has proven to be more resilient and the pace of tightening credit conditions has been slower than the Fed expected.

Price data is also showing signs of continued deceleration.  The annual growth rate of headline Consumer Price Index (CPI) slipped by half a percentage point in October to 3.2% from September’s 3.7%.  Falling energy and goods prices contributed heavily to the soft reading.  Core (excluding the volatile food and energy components) CPI remains somewhat sticky.  It posted a 0.2% increase in October causing the year-over-year rate to drop a tick from 4.1% in September to 4.0% in October, still significantly higher the Fed’s 2.0% goal.  The Personal Consumption Expenditure (PCE) Deflators were also subdued with the headline number reported at 3.0% and the core at 3.5%, year-over-year.

     Signs of ebbing inflation and softer economic growth spurred traders/investors to bet and incorporate into market pricing a rapid pivot by the Fed to stop raising rates and to start cutting rates in the first half of 2024.  Stocks rallied as the Treasury yield curve moved sharply lower during November.  The resulting loosening of financial conditions appears an unwelcome development by the Fed as the central bank has been consistent in messaging that it’s too soon to talk about cutting rates. 

    The Fed’s current restrictive stance of monetary policy will likely continue to exert headwinds on the economy, but it is keeping its options open and insisting it would hike rates if appropriate.  As the risks of doing too much and doing too little are coming more in balance, the Federal Open Market Committee (FOMC) will proceed carefully, especially in an increasingly worrying geo-political backdrop.  The Fed believes that policy needs to stay at a restrictive stance for some time, until inflation is convincingly moving down sustainably toward its 2% target.