Don’t Kid Yourself, the Economic Slowdown is Getting Worse

High interest rates may finally be weighing on the economy…

Late last year, Wall Street agreed on one main topic… an economic collapse was right around the corner. In December, Federal Reserve Chairman Jerome Powell confirmed this speculation. Because, for the first time since the central bank started raising interest rates in March 2022, he said cuts were back on the table in 2024.

But then the Bureau of Economic Analysis reported fourth quarter gross domestic product numbers. Output grew 3.9% in the last three months of the year. That was far above the long-term average increase of 2.1% the country has experienced since the end of the financial crisis in 2008-09.

Now, while we all want growth, in the Fed’s eyes, the scenario was less than ideal. A resilient economy won’t bring down inflation. Expansion above the long-term average means goods demand will remain strong, keeping upward pressure on prices. In Wall Street’s eyes, the numbers meant the rate-hike door was left open.

However, the story started to shift with the release of first-quarter growth numbers. The economy expanded by just 1.6% according to the advanced reading. And with the release of yesterday’s preliminary numbers, the pace of growth had been revised lower to just 1.3%. Both results are well below the long-term average.

Based on recent manufacturing numbers, the outlook is getting worse. Demand for domestically-made goods is dropping. That will weigh on spending and growth. And if the situation persists, it’s likely to give the central bank the room to cut interest rates later this year. That would support a steady rally in the S&P 500 Index.

But don’t take my word for it, let’s look at what the data’s telling us…

Below is a series of charts I made based on the monthly manufacturing surveys produced by the Federal Reserve Banks of Dallas, Kansas City, New York, and Philadelphia. The results are important because the districts those four regional central banks cover make up roughly 25% of national economic output.

Every month, surveys are sent out asking companies in the four districts whether levels of business have improved, worsened, or stayed the same compared to the month prior. The results are then tallied to produce a gauge of activity.

The data is like a real-time indicator of business activity because it’s released a couple of weeks ahead of official government numbers.

I combined the results to produce a gauge of what activity looks like across a number of different areas. And based on what I’m seeing, activity continues to slow. Take a look at the following chart showing new orders. As you’ll notice, the level of work coming in the door continues to contract…

As a result, the lack of demand is eating into company backlog. With fewer orders, businesses are able to complete work still on their plate…

We can also see this by looking at supplier delivery times. As there is less need to ship goods, transportation companies can quickly fulfill orders…

And that’s weighing on employment. As there’s less work to do, companies aren’t in a rush to hire. And, as those same businesses eat through backlog, they’re likely feeling less confident about economic prospects down the road. So, the last thing they want to do is bring on new workers, only to turn around and fire them.

As you’ll notice in this next chart, the level of employment has continued to drop and is now contracting…

The development has led to the average workweek declining as companies try to hold off from firing employees…

This data confirms the anecdotal color from the Fed’s Beige Book survey, saying domestic economic activity has grown slightly from early-April to mid-May.

At the end of the day, this is the type of scenario our central bank is looking for. It has raised interest rates in an effort to slow economic growth and inflation. And while it has taken a while for the slowdown to materialize, it would appear that is finally starting to happen.

The developments should start to provide the Fed with room to cut interest rates later this year. The change will underpin a steady rally in the S&P 500.

Five Stories Moving the Market:

An official gauge of China’s manufacturing activity unexpectedly slid into contraction in May, snapping a two-month run of growth as market demand shrank sharply – WSJ. (Why you should care – the uneven economic growth numbers indicate China’s economy continues to struggle)

Dell forecast current-quarter profit below market estimates, and signaled that higher costs to build servers that meet heavy AI workloads would dent annual margin, sending its shares down more than 17% in extended trading – Reuters. (Why you should care – the company guided fiscal 2025 revenue estimates above expectations)

Apple is planning to overhaul its Siri virtual assistant with more advanced artificial intelligence, a move that will let users control individual app functions with their voice, according to people with knowledge of the matter - Bloomberg. (Why you should care – the shift should boost demand for Apple products, driving revenue higher)

New York Federal Reserve President John Williams said monetary policy is in the right place to get inflation get back to 2%; Williams expects to see price pressures ease further in the second half of 2024 amid a better balancing of the economy - Reuters. (Why you should care – Williams isn’t advocating for rate hikes later this year)

The U.S. economy grew at a slower pace in the first quarter than initially reported, primarily reflecting softer consumer spending on goods - Bloomberg. (Why you should care – slowing economic growth is the Federal Reserve’s desired outcome)

Economic Calendar:

China – Official Manufacturing, Non-Manufacturing, Composite PMI for May

Japan – CPI, Industrial Production for May

Germany – Retail Sales for April (2 a.m.)

France – CPI, PPI (Preliminary) for May (2:45 a.m.)

Eurozone – CPI (preliminary) for May (5 a.m.)

PCE for April (8:30 a.m.)

Baker Hughes Rig Count (1 p.m.)

CFTC’s Commitment of Traders Report (3:30 p.m.)

Fed Releases Balance Sheet Updates on Commercial Banks (4:15 p.m.)

Fed’s Bostic Speaks (6:15 p.m.)