Another round of weak data this morning. The economy may well be contracting right now--which makes sense, given that it got over-inflated after all the Covid stimulus. We'll probably only call it a "recession," technically speaking, once the labor market rolls over, though.
So let's back up. Keep in mind that GDP was going absolutely bonkers after the pandemic stimulus hit--well after the initial reopening rebound. In 2021, nominal GDP soared by 10.7%. Last year, nominal GDP growth still clocked in at 9.2%! "Sustainable" growth, remember, should be more like 4-5%, leaving around 2-3% "real" GDP after stripping out inflation. Instead, we were running twice (and in some quarters, in 2021, thrice) that pace. No wonder things overheated and chronic shortages developed!
Now that the Fed is slamming the brakes, draining liquidity, and hiking rates, the U.S. is obviously slowing. The only remaining question is by how much. The yield curves suggest a sharp downturn is coming, even if some of the data right now is holding up.
And by some metrics, the downturn is already upon us. Certainly, that is true in manufacturing, a leading gauge for the overall economy. Industrial production peaked last September. And this morning, we learned that thanks to inflation, consumer spending also stalled out at the end of last year. "Real" spending dropped 0.3% in December, while nominal incomes grew only half as much as expected. As I mentioned yesterday, in real terms, personal income hasn't grown since November of 2021.
"Falling expenditures normally occur only when the economy is in recession," wrote Chris Rupkey of FWDBONDS in a client note this morning. "The economy is in big trouble here at the start of 2023...The Fed needs to tread cautiously."
In fact, the Fed may already have achieved its goal with rate hikes. The data this morning also showed that core PCE, the Fed's preferred long-run inflation gauge, rose just 4.4% year-on-year last month. Why is that significant? Certainly it's not their 2% target, but it happens to be roughly where the Fed funds rate is now, after the half-point hike in December.
Meaning, as Peter Boockvar points out, that "real rates are FINALLY at about zero," and are no longer in the negative territory that is consistent with "loose" monetary policy. That's right: it has taken the Fed all of this time just to stop stimulating the economy. That was why last March I kept saying what if the Fed just hiked a full point right now??
If markets still expected that inflation would be running 3-4% in the next several years, the Fed would definitely have to keep hiking. But they don't. Expectations have dropped from 3.4% last March to just 2.3% currently, for annual inflation over the next five years. It would seem like their meeting next week would be an excellent opportunity to give rate hikes a rest for the time being.
See you at 1 p.m!
Kelly
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