The weekly note
September 12, 2024
This Week’s Developments in the US Economy
The Implications of a Potential Fed Pause and a Review of Key Indicators
During the most recent meeting of the Federal Open Market Committee (FOMC) on Tuesday, May 3, Federal Reserve Chair Powell signaled a potential pause in ongoing rate hikes. Mr. Powell acknowledged that the previous ten consecutive interest rate increases, combined with the impact of tightening credit conditions related to the collapse of regional banks in March and April, have brough policy to a sufficiently restrictive position needed to achieve a 2% target, albeit over some time. However, in acknowledging that it will take some time “for the full effects of monetary restraint to be realized, especially on inflation,” it seems clear that understanding whether policy is sufficiently restrictive—or perhaps overly restrictive—cannot be known until policy lags can be measured.
In order to gain a deeper understanding of the changes and momentum of crucial economic indicators that the Fed is likely monitoring for policy effects, we categorized a variety of indicators based on their impact areas (i.e. price, sentiment, and economic momentum) and assessed their annualized pace of change over three-, six- and twelve-month periods. To align with the Fed’s policy targets, for example, we view rates of change below 2% as “positive”, between 2% and the Fed’s year-end projection of 3.5% as “neutral”, and anything above 3.5% as “negative”. The results are illustrative of the potential for a long road ahead given the Fed’s repeated commitments to achieving a 2% target over time.
This Week’s Developments in the US Economy
From Soft Landing to Slow and Steady: Why It Matters for Real Assets
Despite hopes for a fast unwinding of tight monetary policy, we see the Fed as likely to take a slow and steady approach in light of (or despite of) this week’s CPI reading. While most market observers have focused on headline (2.5% year-over-year) or core (3.2% year-over-year), we see the four consecutive months of CPI excluding energy, food, and shelter below two percent as a reliable indicator that we are well within soft landing territory (see accompanying visual).
As we evaluate the economic outlook, the good continues to outweigh the bad. Key positive drivers—such as a robust labor market, moderating inflation, and resilient consumer spending—are supporting economic stability, even as risks like slower global growth and geopolitical uncertainties remain. While it is important to recognize that while the downside risks are real, the underlying strength of the economy, particularly in the US, is providing a solid foundation for consumer- and demographic driven sectors, in our view. Further, as inflation cools and the labor market remains robust, the likelihood of a deep recession diminishes. However, we see the Fed making the case next week that slow and steady is the appropriate path—primarily because it does not appear that major collateral damage has occurred.
Progress on Price Stability
US inflation has been steadily declining and price stability appears to be within reach. As of August, headline CPI stands at 2.5%, representing a meaningful 40 basis point drop from the 2.9% recorded in July. Meanwhile, core CPI remained flat at 3.2%. This progress is attributed to several key factors, including improvements in supply chains, stabilization of energy prices, and the cumulative impact of aggressive interest rate hikes. However, while inflation is trending lower, we expect the decelerating pace of inflation to be more modest than many would expect otherwise. Simply put, though we have observed significant cooling in areas like wage growth and durable goods, some inflationary pressures, particularly in housing, continue to be persistent.
Finding Signal in Looking Past the Aggregate Data
Several components have contributed to the improvement in inflation. Aggregate categories such as core goods and energy are in deflationary territory. Durable goods subcomponents such as transportation commodities and household furnishings have both exerted downward pressure on the Headline and Core CPI figures. The trend of slowing price pressures in these categories is supported by faltering demand, as indicated by the subdued year-over-year retail sales figures for motor vehicles and parts dealers and furniture stores reported in July.
Where we see noise—a distraction from otherwise more accurate inflation data—is that shelter continues to exert upward pressure on inflation and contribute to stickiness. While shelter has been on the decline since its peak in early 2023, in August, the shelter component added 2.3 percentage points to Core CPI, up from the previous month’s contribution of 2.2 percentage points. This component continues to be driven by the proxy measure Owners’ Equivalent Rent (“OER”), which in August saw a slight increase in year-over-year inflation compared to the previous month—far from the on-the-ground reality we see today.
Inflation Moderation and Its Impact on Real Assets
While we are still seeing steady job creation, the slower pace of job growth indicates that the risk of overheating and reigniting inflation has diminished greatly. This moderation suggests that the economy is in a more balanced state—growth is continuing, but without excessive inflationary pressures. With inflationary pressures continuing to ease and expectations for a lower rate environment moving forward, we believe this sets the stage for an improved outlook for real assets, particularly those tied to sectors driven by consumer activity and demographic trends. Particularly as supply is expected to come back in line with demand, we anticipate the return of long-term fundamentals and demand-supply dynamics in select commercial real estate sectors.
Market Rates, Catalytic Indicators, and the Week Ahead
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