Economic Outlook – 26 May 2024

The Fed released the minutes of the 1 May meeting of the Federal Open Market Committee on Wednesday, and the readout was a good deal more hawkish than markets expected given the dovish tone Fed Chair Jerome Powell set in the press conference that followed the meeting, during which he seemingly took rate hikes off the table. The minutes showed that “various” participants were willing to tighten more if needed. “Various” is a purposefully vague formulation in the Fed’s taxonomy, but close observers suggest it equates to approximately three to five participants, a significant portion of the 19-member FOMC. Markets are currently fully pricing in only one rate cut before the end of the year and eyeing a one in three chance of a second one. One balance, Fed speakers this week tended to suggest that patience is needed to allow restrictive monetary policy the time to restrain the economy and lower inflation   Federal Reserve Governor Christopher Waller went as far as saying he would need to see ‘several’ more months of ‘good’ inflation readings before lowering rates – implying the Fed is very likely on hold until at least September. But at this point, even a September cut seems optimistic. Between now and that meeting, Fed officials will see four more inflation reports. Even assuming all four readings come in slightly softer than April, the 3-and-6-month annualised trends on core PCE inflation are still likely to be above their respective troughs reached in December of last year. If the Fed didn’t cut then, it’s unlikely they’d would be cutting in September, unless there’s a significant deterioration in the labor market and/or broader economy   The S&P Global Flash Composite PMI increased from 51.3 in April to a 25-month high of 54.4 in May, reflecting an improved economic performance midway through the second quarter. “Not only has output risen in response to renewed order book growth, but business confidence has lifted higher to signal brighter prospects for the year ahead,” the S&P Global report indicated. May’s improved performance was led by the service sector, where business activity surged higher to register the fastest growth for a year with a print of 54.8 (up from 51.3 in April), reversing the slowdown seen over the previous three months. Inflows of new work into the service sector also picked up, registering one of the strongest gains in the past year, though demand was again subdued by a further fall in services exports. On the manufacturing front, the PMI edged up from 50.0 in April to 50.9 in May to signal an overall modest improvement in business conditions within the goods-producing sector. Both output and employment made a stronger positive contribution to the PMI than they did in April. The drag from new orders and stocks of purchases moderated. Optimism about output in the year ahead rose again in both manufacturing and services in response to brighter business prospects. However, companies continued to report doubt about the economic outlook, citing the upcoming elections, wider geopolitical uncertainty, and the possibility of higher-for-longer interest rates.   Durable goods orders increased 0.7% in April, a print stronger than the 0.8% decrease expected by the median economist forecast. Orders in the transportation category increased 1.2% as orders in vehicles/parts hikes 1.5% while orders for non-defence aircraft dropped 8.0% after a 7.7% jump the previous month. Excluding transportation, orders increased 0.4%, three ticks above the consensus forecast. The report showed, also, that orders for non-defence capital goods excluding aircraft, a proxy for future capital spending, rose 0.3% m/m (consensus at +0.1%) after decreasing 0.1% in March. On a three-month annualized basis, “core” orders were flat     After decreasing 3.7% the prior month, existing-home sales fell 1.9% to 4,140K in April (seasonally adjusted and annualized), flying in the face of the consensus forecast calling for a 0.8% increase. Contract closings declined in the single-family segment (-2.1% to 3,740K), while they remained stable in the condo segment (at a post-pandemic low of 400K). On a 12-month basis, the total number of transactions was down 1.9%, but seeing how the level of transactions in April 2023 was already depressed, this figure does not accurately reflect the sharp slowdown in the resale market since mortgage rates began to rise. For a better idea of the situation, suffice it to say that the sales level in April was about 26% below pre-pandemic levels and 37% below the most recent peak reached in January 2021 (6,600K)New home sales notched a sharper-than-anticipated 4.7% drop over the month. Although builders have been fairly successful using sales incentives to stabilize demand, April’s downturn suggests that some builders may be struggling to offset the recent leg up in financing costs. Rising resale inventories may be another hurdle weighing on new home demand. That said, plentiful supply continues to be a tailwind for builders. New home inventories in April rose to their highest level since 2008, able to sustain 9.1 months of sales. Furthermore, builders surveyed by the NAHB stepped up their use of price cuts and mortgage rate buy-downs in May, which may help to bring buyers back from the sidelines   According to the Wall Street Journal, the Fed and other federal banking regulators will require smaller capital increases from large banks than they had earlier proposed as part of the Basel III endgame. The banks are likely to require an additional 10% in capital buffers, down from a proposed 20%. US banks told regulators that the larger capital increase would have forced them to discontinue a range of products and shut down businesses   The major indexes recorded widely varying results over the week, with the Dow Jones Industrial Average recording its biggest weekly loss (-2.33%) since early April, while the technology-heavy Nasdaq Composite continued its recent march into record territory. The broad S&P 500 Index was roughly flat, while small-cap stocks lost ground. The disparate returns were also reflected in the substantial underperformance of an equal-weighted version of the S&P 500 Index, which trailed its more familiar, market-weighted counterpart by 127 basis points (1.27 percentage points). The market was scheduled to be closed the following Monday in observance of the Memorial Day holiday   A primary factor driving the market’s divergence was the gain in shares of artificial intelligence chipmaker NVIDIA, now the third-largest company in the S&P 500 by market capitalization (trailing only Apple and Microsoft). The company reported its first-quarter earnings after the close of trading Wednesday, but anticipation over the report seemed to play an important role in driving sentiment even earlier in the week. (As of Tuesday, Bank of America noted that NVIDIA had accounted for 37% of the S&P 500’s earnings-per-share gains over the previous 12 months, while Bloomberg reported that the stock had been responsible for 25% of the S&P’s 11.3% gain for the year-to-date period.) After beating consensus estimates, NVIDIA shares rose 9.3% on Thursday, adding roughly USD 220 billion to its market capitalization   In terms of data release, consumer confidence is out on Tuesday. The disconnect between consumer spending and confidence has been a widely followed development over the past year. Household confidence, as measured by the Conference Board, has fallen for three straight months and was at its lowest in April since the summer of 2022. Meantime, real consumer spending expanded at a 2.5% annualized rate in the first three months of the year and closed the quarter 2.4% higher than it was the prior year. Why is confidence low when spending is solid? Stubborn price growth explains at least some of the gap. Inflation has eased from its breakneck pace in 2022, but prices continue to rise and the sticker shock of the past few years has compounded to a lackluster outlook on the economy. In April, gas prices were up, retail sales stalled, stock prices ebbed and the unemployment rate moved up a tenth   Personal income and spending is out on Friday. Despite faltering confidence, the household sector continues to demonstrate resilience. Consumer spending came in stronger than expected in March among moderating growth in real disposable income. To make ends meet, the personal saving rate has fallen since the beginning of the year and is sitting at a historically low 3.2%. Elevated borrowing costs have slowed the pace of expansion in consumer credit, but the steady rise in credit card debt and low saving rate suggest consumers are pulling out all the stops to keep spending.

The flash UK PMI for May registered at 52.8, which indicates private sector expansion but the figure was a drop from April’s print of 54.1 and below market expectations of 54. While there has been a rebound in manufacturing production, new business volumes in the services sector rose at their weakest rate in the year-to-date. The manufacturing PMI is at 51.3 in May, a 22-month high, while services PMI fell from 55 to 52.9, a 6-month low. Although the composite PMI has fallen in May, the survey data is consistent with GDP rising by around 0.3% in Q2. The data also provides some encouraging news on cooling inflation in the services sector. According to this survey, service providers are experiencing their weakest cost pressures in over three years as the temporary surge in wage-related cost growth observed in April (when the circa. 10% increase in the National Living Wage came into force) shows signs of fading in May   UK retail sales figures for April have been released and, overall, they were 2.3% MoM, and down 2.7% YoY, sales (excl. fuel) were down 2.0% MoM and down 3.0% YoY. Sales volumes fell across most sectors, with clothing retailers, sports equipment, games and toys stores, and furniture stores faring badly as poor weather reduced footfall. April saw rain hitting 155% of the average, while there was only 79% of the normal amount of sunshine. Only department stores and online showed any improvement, but even here the improvement for online was only relative, and the value of online sales fell away, albeit not as much as other channels of shopping. Looking forward, improvements can be expected as the year progresses, and earnings figures, which have been rising (up 2.5% in Q1, feed through to sales and confidence   Consumer prices in the UK fell less sharply than expected in April, with the core reading falling to 3.9% from 4.2% the month before. Economists expected a deeper pullback to 3.6%. The chances of a June rate cut from the Bank of England declined to 6% after the data were released from about 50% before.

The PMI flash composite output index 52.3 in May, up from 51.7 in April, and just as last month, somewhat above expectations (52.0).  Looking under the hood, Manufacturing PMI saw a pick-up in new orders and rose sharply to 47.4, from 45.7, clearly above expectations of 46.1. Services PMI, however, remained unchanged at 53.3, just below expectations of 53.7. Services price indicators were somewhat lower while business activity and employment were unchanged or higher, which is just the ideal composition for in a soft landing. Eurozone negotiated wages, released just an hour after the PMI flash, rose 4.7 percent YoY in the first quarter of 2024, in line with the pace during second half of 2023 and above expectations. With unemployment glued a record lows, decelerating wages is one of the keys the ECB is looking for in order to declare victory over inflationThe ZEW Indicator of Economic Sentiment for the Eurozone, which measures the level of optimism that analysts have about the expected economic developments over the next six months, is still on the rise. The index turned sharply higher in February this year, and has been beating market expectations every month since. While an ECB rate cut in June is a done deal, optimism bordering on euphoria, together with wage data, signals the need for a careful approach ahead. ECB President Christine Lagarde said in an interview with Irish television channel RTE that there was a “strong likelihood” that the central bank would reduce interest rates in June. Asked if people should expect a rate cut at the next ECB meeting, she replied: “No predicament, no prescription, no commitment, but it is a case that if the data that we receive reinforce the confidence level that we have—that we will deliver 2% inflation in the medium term, which is our objective, our mission, our duty—there is a strong likelihood.”   In local currency terms, the pan-European STOXX Europe 600 Index ended 0.45% lower, as questions emerged about the pace of potential interest rate cuts this year. Major stock indexes were mixed. Italy’s FTSE MIB lost 2.57%, while France’s CAC 40 Index declined 0.89%. Germany’s DAX was little changed.

Chinese banks left their one- and five-year loan prime rates unchanged at 3.45% and 3.95%, respectively, as expected, after the PBOC kept its medium-term lending rate on hold. Some analysts anticipated that the central bank will continue to loosen policy this year and potentially reduce its reserve requirement ratio again, following a surprise cut in January, to spur demand   The People’s Bank of China (PBOC) announced a historic rescue package for the property sector in the prior week as data showed no sign of letup in China’s housing crisis. Measures included a re-lending program that would extend RMB 300 billion in low-cost funds to a select group of state-owned banks to lend to local state-owned entities for buying unsold homes, removing the nationwide floor level of mortgage rates, and lowering the minimum down payment ratio for home purchases. While most investors welcomed the plan, some remained skeptical on whether it will draw a line under the property slump, which remains a key drag on the world’s second-largest economy   Chinese stocks retreated as fears that rates would remain elevated in the U.S. offset optimism about Beijing’s latest measures to shore up the ailing property sector. The Shanghai Composite Index declined 2.07%, while the blue-chip CSI 300 lost 2.08%. In Hong Kong, the benchmark Hang Seng Index fell 4.83%, according to FactSet.      
Sources: T. Rowe Price, Wells Fargo, Handelsbanken Capital Markets, TD Economics, National Bank of Canada, Marina Cassar Derjavets.