Economic Outlook – 5 May 2024

Markets breathed a sigh of relief on Friday morning as yields on US Treasuries tumbled after April nonfarm payrolls grew a less-than-expected 175,000. The number fell considerably short of the 240,000-consensus forecast, and the prior-two-months reading was revised down by 22,000. The unemployment rate rose to 3.9%, up 0.1% from March, while average hourly earnings grew less than anticipated. Along with a rise in job openings data released earlier in the week, investors are seeing signs that tightness in the labor market is easing. After the data, markets were quick to price in a second rate cut by the Fed before the end of the year, with the first fully priced for September. 
Additional soft data were reported midmorning on Friday as the Institute for Supply Management’s non-manufacturing index fell to 49.4, the lowest reading since December 2022.
Ahead of Wednesday’s press conference following the latest Federal Open Market Committee meeting, markets were primed for a “hawkish hold” after a series of hotter-than-expected inflation prints. Instead, Fed Chair Jerome Powell said it is “unlikely” the next policy move will be a hike and that rate cuts remain the Fed’s base case, only later than expected. Additionally, the FOMC voted to slow the pace of quantitative tightening by more than expected beginning in June, allowing $25 billion a month of Treasuries to roll off the balance sheet from the current $60 billion a month. Markets expected a $30- billion-a-month pace. Powell said he remains confident that inflation will moderate over the balance of the year, though he is less confident than he was earlier. The post-meeting FOMC statement acknowledged that there has been a lack of further progress toward the committee’s 2% inflation goal in recent months. Markets rallied strongly after Powell took hikes off the table, though the gains faded away late in Wednesday’s session and stocks closed lower on the day, though they rallied on Thursday and early Friday.
While the softening in wage growth will come as welcome news for Fed officials, it needs to be weighed against other measures of employee compensation, particularly the Employment Cost Index (the Fed’s preferred wage measure) which showed an unexpected acceleration. Moreover, after rising by a robust 1.5% in 2023, growth in non-farm productivity slipped to a near stall speed in Q1. Taken alongside last quarter’s uptick hourly compensation, unit labor costs (ULC) also rose sharply higher.  This has important implications for inflation. ULC can best be thought of as a productivity adjusted cost of labor, making it a useful gauge on the extent to which the nominal pace of compensation growth is running above (or below) what would be consistent with achieving 2% inflation. However, with the Q1 reading not only turning higher but also running at an annualised rate that’s more than double where it should otherwise settle, provides yet another signal that progress on the inflation front has indeed stalled.
The Job Openings and Labor Turnover Survey (JOLTS) showed a decrease in the rate of job openings, hiring and quits, which presages further easing in employment growth in the months ahead. What’s more, April’s drop in consumer confidence to the lowest level since July 2022 was partly prompted by mounting labor market concerns, with consumers reporting that jobs are becoming harder to find. That said, initial jobless claims and continuing claims have both remained low over the past few weeks, which suggests that layoffs are not accelerating and those that need a job are finding one relatively quickly. All told, some further cooling appears in order, but a material deterioration in labor market conditions does not appear imminent.
The ISM manufacturing headline index slipped to a reading of 49.2 during April, falling back into contraction territory and providing a reminder that the factory sector remains constrained by higher interest rates. However, the prices-paid index jumped more than five points to the highest level since 2022. The rise in manufacturing prices paid reflects the recent uptick in commodity prices and offers more evidence that, moving forward, goods prices are not likely to be the same disinflationary force as they were last year   Similarly, a leap in the ISM services prices-paid index during April points to continued stickiness in service sector inflation, even as activity looks to be downshifting. Similar to its manufacturing counterpart, the headline ISM services index faltered in April and dropped below the 50-demarcation line indicating contraction for the first time since December 2022. The business activity, new orders and employment sub-indexes all fell back during the month. Over the past several years, services activity has been seemingly unmoved by higher interest rates thanks to strong household finances and pent-up demand from the pandemic. One month of data does not make a trend, but April’s decline in the ISM services index suggests that services activity may be starting to feel the effects of tighter monetary policy   Total construction spending declined 0.2% in March, the second drop in three months. Overall construction spending has gotten off to a slow start in 2024, and on balance, total spending declined in the first quarter. Residential spending weakened in March with pullbacks across both single-family and multifamily segments. Meanwhile, nonresidential spending edged up slightly, but that was fueled by spending on the public side, particularly for infrastructure projects. Private nonresidential spending fell for a third straight month as developers remain constrained by weak demand for commercial real estate, higher interest rates and tighter lending standards. A downdraft in nonresidential project starts for these types of construction and a pullback in architecture firm billings suggests a drop in private nonresidential activity is ahead in the near term   The US Treasury will borrow $243 billion during Q2, $41 billion more than its late January estimate. The Q3 borrowing estimates is $847 billion. The department will increase bill auction sizes in the coming days while keeping bond auction sizes steady in the May to July quarter. A program to buy back off-the-run Treasuries to increase liquidity is set to begin on 29 May.
Stocks ended higher following a volatile week featuring a raft of economic and earnings data. Growth stocks outperformed value shares, which were flat overall for the week. Small-caps outpaced large-caps, helping lift the small-cap Russell 2000 Index back into slightly positive territory for the year-to-date period. It was the second-busiest week of first-quarter earnings reports, and a positive reception to Apple’s earnings release after the close of trading on Thursday seemed to help drive a rebound in overall sentiment. The company beat consensus revenue expectations, but investors also appeared enthused by Apple’s announcement that it would buy back USD 110 billion of its own shares, the largest such repurchase in history. Another notable mover for the week was Tesla, which surged over 15% on Monday after founder Elon Musk made a surprise appearance in China following news of the government’s tentative approval of the self-driving technology the company has under development   In terms of data release, the consumer credit print will be out on Tuesday. Consumer credit grew $14.1B in February. Through the first two months of the year, consumer credit has increased $31.8B, which is already high enough to surpass the growth seen in each of the last two quarters of 2023 and to notch the largest quarterly increase since Q2-23. Revolving credit (primarily composed of credit card debt) has done most of the heavy lifting here, as non-revolving credit (primarily composed of instalment debt such as auto and student loans), has felt pressure. While consumer credit outstanding has expanded solidly over the past few years, consumers have reduced the amount they have been drawing on revolving credit lines each month. The monthly average increase in revolving credit balances was $13.3B throughout 2022, and it decreased to a monthly average increase of $8.9B in 2023. Year-to-date, the monthly average increase so far in 2024 has hovered around $9.9B, although this should be taken with a grain of salt, given there are only two months of data available this year. Indeed, consumers seemingly both do not need to and do not want to draw on credit at the same pace they did in 2022 when inflation was rampant and real disposable income growth was negative   The consumer sentiment print is out on Friday. It has started the year with a string of strong prints and has yet to drop below an index level of 76. This is a marked improvement from where sentiment stood in 2023, when it only cracked above 70 for a single month, even dropping as low as 59. A sizable gap between weakness in the more inflation-focused consumer sentiment measure from the University of Michigan and strength in the more labor market-focused consumer confidence measure from The Conference Board persisted between 2021 and 2023. The two indices usually track close together, but a remarkably strong labor market and decades-high inflation put pressure on consumers’ pocketbooks and drove a wedge between the two indices. However, recent data have shown a gradual softening in the labor market beginning to materialize, in addition to inflation data that, until recently, had been making progress in coming down. The narrowing of the gap between the two indices is likely due in large part to a reversal in the trends of the underlying employment and inflation data that initially drove the wedge. A key component in the continued rebound of the inflation-focused consumer sentiment measure is consumer inflation expectations remaining well-anchored. In April, year-ahead inflation expectations rose to 3.2%, while expectations 5-10 years out hit 3.0%. Despite hitting the highest level in five months, long-term expectations are still consistent with its recent range and will be considered “anchored” by the Fed. Even so, if inflation data continue to come in sticky, the risk remains that consumers could begin to shift their expectations higher and put a damper on the thus-far strong sentiment readings in 2024.

Mortgage lenders in the UK approved 61,325 mortgages in March, up from 60,497 in February, according to the Bank of England. The increase to an 18-month high provided further evidence that the housing market began to recover this year. Still, the Nationwide Building Society’s house price index for April fell 0.4% sequentially, the second consecutive monthly decline and a sign that activity may be moderatin   British services companies reported the strongest upswing in activity in almost a year during April, despite a new surge in cost pressures, according to a survey on Friday that pointed to a solid rate of economic growth. The S&P Global UK Services Purchasing Managers’ Index rose in April to 55.0, its highest level since May 2023 and up from a preliminary reading of 54.9. Readings above 50 represent expansion. The survey showed a robust increase in new orders, but also the biggest acceleration of cost pressures since August – something that is likely to be noticed by Bank of England officials who next week will meet to set interest rates. Many businesses attributed the inflation squeeze to a 10% increase in the national minimum wage in April, while some also said rising salary costs were a reason why employment growth slowed to its lowest level this year. “The latest survey results are consistent with the UK economy growing at a quarterly rate of 0.4% and therefore pulling further out of last year’s shallow recession,” said economics director Tim Moore from S&P Global Market Intelligence. Relief at a turnaround in the economic outlook was commonly cited as a factor supporting sales pipelines in April. However, there were also reports that clients remained somewhat risk averse and under pressure from elevated inflation. The rising fortunes of the dominant services contrast with the manufacturing PMI, which dipped back below the 50 mark after venturing briefly into growth territory in March. The composite PMI (which combines Friday’s services PMI with the earlier factory survey) rose to 54.1 from 52.8 in March, marking a one-year high.  

Eurozone gross domestic product surprised to the upside, expanding 0.3% in the first quarter, after shrinking 0.1% in the final three months of 2023. The contraction registered in the fourth quarter of 2023 was a downward revision from 0.0%, meaning that the economy fell into a technical recession in the second half of last year. Meanwhile, annual consumer price growth was steady in April at 2.4%, but core inflation (which excludes energy and food prices) slowed to 2.7% from 2.9%   European Central Bank (ECB) policymaker and Bank of France Governor François Villeroy de Galhau said that the latest data strengthened confidence that inflation would return to the 2% target by next year, suggesting that the ECB should be able to start lowering borrowing costs in June   Eurozone Core CPI for April fell to 2.7% YoY from 2.9%, which was one tenth less than expected but enough for the ECB to cut rates in June. Headline inflation was flat at 2.4%, which was fully in line with expectations.  Services experienced disinflation for the first time since November, which is good news for the ECB. Meanwhile goods disinflation continued, but at a more modest pace compared to earlier months this year.  For Spain, which was first to release the data for April, headline inflation was 3.4% YoY, slightly higher than the previous month at 3.3%, but in line with expectations, after rising gas and electricity prices during the month. Germany’s headline inflation also rose slightly and in line with expectations, to 2.4% YoY from 2.3%. France’s headline inflation rate was flat at 2.4% YoY, one tenth higher than forecast. Italy’s headline inflation fell to 1.0% YoY, lower than the 1.2% that was forecast   In local currency terms, the pan-European STOXX Europe 600 Index ended 0.48% lower. Investors appeared to become more cautious amid mixed corporate earnings and uncertainty surrounding the outlook for interest rates after June. Major stock indexes were mixed. Germany’s DAX weakened 0.88%, France’s CAC 40 Index lost 1.62%, and Italy’s FTSE MIB declined 1.81%.

The value of new home sales by the country’s top 100 developers slumped 45% in April from the prior-year period, in line with March’s decline, according to the China Real Estate Information Corp. Transactions fell by 13% from the previous month. China’s housing downturn, now in its fourth year, remains a significant drag on the economy, as it has made consumers reluctant to spend and left developers with a massive supply of unfinished apartments   The official manufacturing Purchasing Managers’ Index (PMI) was a better-than-expected reading of 50.4 in April, down from March’s 50.8, marking the second straight monthly expansion. The nonmanufacturing PMI reached a below-consensus 51.2, easing from 53 in March, as new orders and services activity stalled from the prior month. Separately, the private Caixin/S&P Global survey of manufacturing activity edged up to a better-than-expected 51.4 in April, marking its 16th month of expansion   Slowing industrial profits growth pointed to deflationary pressures that continue to weigh on China’s economy. Profits at industrial firms declined in March and advanced 4.3% in the first quarter of 2024 year over year, slowing from a 10.2% gain in the January to February period, according to the National Bureau of Statistics   China’s top decision-making body, the 24-member Politburo, pledged to implement prudent monetary and fiscal support to shore up demand at its April meeting last Tuesday. Officials stated that China would make flexible use of monetary policy tools to restore growth, including possible cuts to interest rates and the reserve requirement ratio, which sets the amount of cash that banks must set aside in reserve   Chinese stocks rose in a holiday-shortened week on hopes that the government will ramp up support. The Shanghai Composite Index gained 0.52%, while the blue-chip CSI 300 edged up 0.56%. In Hong Kong, the benchmark Hang Seng Index added 4.67%, according to FactSet. Markets in mainland China were closed from Wednesday for the Labor Day Holiday and will reopen on Monday, May 6. Hong Kong markets were closed Wednesday but reopened Thursday.      
Sources: T. Rowe Price, MFS Investments, Wells Fargo, Handelsbanken Capital Markets, TD Economics, Reuters, M. Cassar Derjavets.