Lower Rates, Data Be Damned!

Fed Determined to Ease

A stream of positive data last week signaled strength in the US economy. None of those persuaded Federal Reserve officials to suggest that a rate cut may not be necessary. Accordingly, markets have placed a 100% probability on a reduction in the Federal Funds rate on September 18 at the conclusion of a two-day meeting of the Federal Open Market Committee. The only unknown is whether the rate will be lowered by 25 or 50 basis points.

With policymakers and investors allowing no room for negative surprises that may spoil the party, the risk is that the Fed may be forced to increase rates at a future date in response to shocks — a process that came to be known as “stop-and-go” measures during the 1970s, and was a major factor in making inflation sustained during that decade.

Now let us go to the data from last week. On Monday, we learned that orders for durable goods rose by a strong 9.9% month-on-month in July, more than offsetting the 6.9% fall in June. July’s rise was also well above the consensus expectation of a 5% increase. So much for concern that US manufacturing activity is in cyclical decline.

Also bolstering optimism on the economy was the upward revision in the second quarter gross domestic product estimate by the Bureau of Economic Analysis. According to the new figures, GDP rose by 3%, up from the original estimate of 2.8%. The rate of change was more than twice the 1.4% recorded in the first quarter. A major contributor to the upward revision was the 2.9% increase in consumer spending. For those who pooh-pooh the significance of second quarter GDP as old news, GDPNow published by the Federal Reserve Bank of Atlanta has a response. As of August 30, its GDPNow estimate for the current quarter is 2.5% — certainly not a figure that warrants lower interest rates. And the 2.5% estimate is an upward move from the previous estimate of 2%.

On Tuesday, the S&P Case-Shiller 20-city home price index posted a rise of 6.5% in June from a year earlier. Just as important, the index increased by 0.6% month-on-month in June suggesting that US home prices are continuing to go up despite reaching a record high.

Elevated prices have put homes beyond the reach of most first-time buyers — something for which the Federal Reserve is partly responsible through its Quantitative Easing during 2020 - 2022. The central bank purchased mortgage-based securities, lowering yields, increasing demand for housing, and pushing up prices. On August 28, the central bank held $2.3 trillion of MBS in its portfolio, 73% higher than the $1.4 trillion it owned in March 2020. The Fed has been putting the securities into the market since mid-2022 worsening homebuyers’ frustration by increasing the mortgage rate amidst a scarcity of available housing.

A consequence of sky-high home prices is that buyers previously hoping to buy have been forced into the rental market, pushing up rents which are a major component of various price indexes. In the much anticipated Personal Consumption Expenditure price index released yesterday, the BEA points out that increase in housing cost in July was a major component of services inflation — a feature that is unlikely to lose its importance until housing affordability improves.

While investors cheered the annual PCE inflation rate staying unchanged at 2.5% in July — a slight acceleration to 2.6% had been the market consensus — other elements within the index suggested no rapid move toward the Fed’s 2% target rate. Month-on-month change in the index accelerated from 0% in May and 0.1% in June to 0.2% in the latest month. Annual inflation in the core PCE index (which excludes food and fuel) remained unchanged at 2.6% for the third successive month.

Perhaps the labor market, about which Powell has repeatedly expressed concern in recent speeches, is falling apart? Hardly. Initial jobless claims, an early indicator of labor market issues, fell by 2,000 to 231,000 in the latest week ending August 24.

Neither indicators of economic strength, nor signs of inflation remaining a significant force, stopped the major equity indexes from rising sharply yesterday. Why worry about such factors when the Fed has green-lighted a rate cut next month? Instead, market speculation is focused on whether the central bank would cut by 50 basis points instead of 25 prompted by whether investors would consider the jobs report to be released next Friday to be “weak”.

The Fed, on the other hand, has a broader responsibility. It is not to please players in the market with policy moves that boost market valuations but to ask itself whether policy easing is justified when overall production and consumer spending are robust, and when its own inflation target has not been met.

I expect the Fed to fail this test.

Dr. Komal Sri-Kumar

President

Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

August 31, 2024

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

This publication is for information purposes only. Past performance is no guarantee of future results. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. Any opinions expressed are current only as of the time made and are subject to change without notice. Sri-Kumar Global Strategies, Inc. assumes no duty to update any such statements. Any holdings of a particular company or security discussed herein are under periodic review by the author and are subject to change at any time, without notice. This report may include estimates, projections and other "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. This publication is not to be used or considered as an offer to sell, or a solicitation to an offer to buy, any security. Nothing contained herein should be considered a recommendation or advice to purchase or sell any security. Sri-Kumar Global Strategies, Inc., or its employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time without notice. ©Copyright 2024 -- Sri-Kumar Global Strategies, Inc., 312 Arizona Avenue, Santa Monica, California 90401; Telephone: +1-310-455-6071