Nothing Recedes Like Recession

Recent economic data reports have been mixed, but generally consistent with moderate economic growth in the near term. That won’t stop investors from worrying. The overall theme of domestic strength vs. global softness is going to continue. However, there are likely to be some important issues in the job market and dilemma for Fed policy in the months ahead.

The consumer accounts for 70% of the overall economy. Job growth, wage growth, and low gasoline prices are all supportive. Consumers are aware of trouble out there (a lower stock market, global financial turmoil) and the election-year rhetoric has fanned the flames (more than 5.5 million private-sector jobs added in the last two years = “a terrible job market?”). Yet, consumers are feeling better about their current financial situation then they have in nearly a decade.

Businesses are still cautious. New orders rebounded sharply in January, although the underlying trends in capital goods orders and shipments remain relatively soft.

The weak global economy and strong dollar appear to be having a greater impact on U.S. exporters. Foreign trade should be more of a drag on GDP growth in the first half of this year. China’s leaders are facing a tough task convincing investors that they are capable of managing the economy. The People’s Bank of China is working to counter expectations that a devaluation is coming – it has the currency reserves to do that ($3.2 trillion at the end of January), but it has been burning through those reserves at a rapid pace (roughly $100 billion per month). Whether Chinese leaders succeed in restoring confidence will likely be the biggest story in the global economy this year.

Meanwhile, the U.S. job market is getting tighter and inflation pressures appear to be building. Oil and other commodity prices remain low, but rents are picking up and higher labor costs are putting upward pressure on services. Traditionally, many firms will raise prices at the start of the year to see if they stick. So, much of the rise in core inflation may be transitory. However, the trends in rents and labor costs have been building for a while. The Fed has to set policy with an eye to where the economy will be a year from now and there should be a lot less slack in the labor market over time.

Yellen’s monetary policy testimony, speeches by other Fed officials, and the January FOMC minutes all suggest that the central bank remains in tightening mode, looking to raise short-term interest rates again at some point. However, since the December hike, the stock market has declined, credit spreads have widened, and the dollar has strengthened – all likely to restrain growth to some extent. Global conditions should prevent the Fed from raising rates at the policy meetings in mid-March and late April. However, at this point, despite what the markets expect, a June hike should definitely be on the table.

The late Rudi Dornbusch said that economic expansions never die of old age, asleep in their bed – the Fed murders them.

© Raymond James

© Raymond James

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