The Fed Faithful

If the financial markets have a religion, we think we know what it is: a deep and abiding faith in the ability of an omniscient Federal Reserve to ride to the rescue if and when the economic weather turns bad.

It’s hard to tell exactly where the economy is right now, but it’s very unlikely to be in a recession or need a rescue yet. The Atlanta Fed’s GDP Now model is tracking 3.3% annualized growth in the second quarter, while our models suggest a growth rate of 2.5%. Both of these are above the 20-year average growth rate of 2.0%.

However, not all the economic signs are as positive. The ISM Services index came in at 49.4 in April, the first reading below 50.0 since December 2022. The business activity component, at 50.9, was the lowest since the onset of COVID in 2020. This is important to us because readings below 50 signal contraction. The ISM Manufacturing index came in at 49.2, the seventeenth month below 50.0 in the past eighteen months.

During COVID, services were locked down in many states for a long time, with many of those workers receiving checks from the government, which they in turn spent on goods. Since opening up, goods have been weak, while services have recovered. That process appears complete now, and the dip in services could signal problems.

It could also be why the labor market lost at least a little bit of luster in April, with slower job growth, slower wage growth, and fewer hours worked. Nonfarm payrolls grew 175,000 for the month, less than the 225,000 the consensus expected.