We approach the second half of 2024 with two primary economic questions related to the pace of moderation in overall growth and disinflation
Recent data have provided a glimpse of hope that consumers may be moderating spending habits, which would be positive for the Fed’s inflation battle
We provide an update on the recent Freddie Mac announcement of a proposed program to purchase second-lien mortgages
As we begin the final month of Q2, there are two key economic questions looking forward. First, will growth continue to moderate from the torrid pace experienced in the second half of 2023? Second, will this moderation be enough to materially slow inflation growth toward the Fed’s 2% target? Additionally, will this scenario require notable cooling of the labor market (i.e., higher unemployment)? Looking back to 2023, GDP growth averaged an annualized 4% pace in the second half of the year, more than double what the Fed currently considers the economy’s long-run potential growth rate. If excluding the more volatile categories of inventories and trade, real domestic demand averaged approximately 3.5% annualized growth over that same timeframe. This was the result of strong consumer spending and hefty government outlays, not to mention solid contributions from the housing sector.
In Q1 2024, annualized GDP growth slowed to 1.3% according to the most recent estimate, but real domestic demand was still a solid 2.5%. Q2 is expected to show continued moderation in final demand, but anything above 2% is still above trend growth estimates for the economy. Based on recent projections, the Fed seems to be a bit optimistic that a return to 2% inflation may be achieved with little or no economic pain (soft landing), but if the central bank does indeed have to keep interest rate policy restrictive for a longer timeframe to achieve its price stability objective, the risk of greater economic deterioration increases. This would ultimately be good for the inflation battle, but it could also come with increased unemployment and credit delinquencies.
As noted in previous commentaries, household liquid assets data from the Fed at the end of 2023, in concert with cumulative inflation effects, suggested that personal consumption was poised to slow in 2024. The initial Q1 data suggested otherwise, but the April personal income and spending report showed new signs of moderation. Inflation-adjusted (real) spending was initially estimated to have advanced 2.5% annualized in Q1, down only slightly from the approximately 3% annualized pace in 2H 2023, but the April report showed downward revisions to both February and March real spending figures, dropping the Q1 figure down another 50 basis points (bps) to 2%. April real spending declined 0.1%, and if this moderating trend continues, it will bode well for the chances of a late 2024 rate cut by the Fed.
Looking Ahead
The next major data release will be the May jobs report at the end of this week. For much of 2024, any major data release that just matches expectations has been well received (bonds and stocks rally) and just the opposite for an upside surprise. Current expectations are for 190,000 jobs added to nonfarm payrolls and no change in the unemployment rate at 3.9%. The May CPI report will follow next week with expectations for another 0.3% monthly increase in the core rate.
Fedspeak during the month of May largely followed the same message of patience with regard to any shift to rate cuts (or hikes). The minutes of the May 1 FOMC meeting, released on May 22, offered no true revelations, although it was clearer that the discussion of potentially needing more rate hikes was not unanimous. That said, the focus of virtually all Fed leaders in their recent comments has been on the timing of eventual rate cuts and not on whether more rate hikes may be needed. Fed Governor Waller, who has been one of the more hawkish Fed commentators over the last year or so, did say on May 21 that additional rate hikes are “probably unnecessary” in light of recent inflation data. If the Fed were to suggest that hikes are back on the table, a sharp sell-off in Treasuries would ensue with implied rate volatility likely testing or exceeding last October’s levels. That scenario would almost certainly include a repricing of fixed income spreads wider, particularly down the credit spectrum. The Fed understands this and would only likely open that box if they felt it were truly needed (e.g., another upturn in inflation data for multiple months).
Update: Big Freddie Mac Announcement
Last month we highlighted Freddie Mac’s announcement of a new proposed program to purchase closed-end second mortgages. This included a comment period that expired on May 22, and it garnered the highest response rate to a potential change in housing regulation in a decade. The majority of major interest groups that responded opposed the change, including a group of Republican congressmen representing both the House and Senate. However, the opposition was not completely along political party lines, with some Democrats opposing as well. Much of the opposition focused on concerns that it would further fuel inflation, compete with private capital, and increase systemic risk while not providing benefits to housing affordability. The FHFA has until June 22 to approve or disapprove of the proposal and, given the strong opposition from several political and market groups alike, it’s unlikely that it would move forward in its originally proposed form. Stay tuned.
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