Growth, Inflation and Economic Control

Yesterday the May FOMC meeting minutes showed Committee members were of one mind last month for a larger second-round hike of 50bps.?Furthermore, most participants judged that 50bp hikes would likely be appropriate?“at the next couple of meetings.”??Thus, not only is a half a percentage point increase probable in June, but potentially in July as well.?

Participants noted that by?“expediting the removal of policy accommodation,”?the Committee would be well positioned to?“assess the effects of policy firming”?and the need for further policy adjustments.?Fed officials also noted that a potentially?“restrictive”?stance may be appropriate depending on the evolving economic outlook and risks to the outlook. In other words, the Committee is anxious to raise rates?“expeditiously”?now to tamp down inflation, but also to ensure ammunition to potentially cut rates more quickly to boost the economy from a more dire or prolonged economic contraction.?

Up until this point, Chairman Powell has been clear in the Fed’s focus on prices and intent to raise rates until inflation is declining in a clear and meaningful fashion, as the economy, he says, is strong and strong enough to withstand a further backup in rates.?There are, however, already clear cracks in the economy.?Such cracks are increasingly evident now with the latest round of data highlighting a weaker consumer and depressed production numbers, although a slowdown was also becoming apparent at the time of the May FOMC rate announcement.?

Although some noted reports of inflation undermining sales, most participants were more broadly dismissive of the decline in activity in the first quarter.?Such a minimal focus on the growing weakness and lack of concern regarding a further potential decline in domestic activity suggests the Fed was still narrowly focused on price pressures earlier this month, despite the rising risk of recession. But can that continue?

With the June FOMC meeting just 20 days away, a second-round 50 bps hike is already priced in.?However, as we move into the second half of the year, despite earlier blinders, the Fed will have an increasingly difficult time justifying maintaining a robust pace of rate hikes as weakness becomes increasingly – and overwhelmingly – apparent.?We contend the Fed may be well advised to reduce the pace of rate hikes come September if – and this is a big if –?the goal is to achieve any derivative of a?“softish”?landing.

In international news, Chinese Premier Li Keqiang held a rare video call with thousands across the nation warning of an economic crisis as the country struggles to balance Covid controls and economic growth. The Premier’s comments, however, appear somewhat at odds with the message from Chinese President Xi Jinping who continues to push for necessary measures to control the Covid outbreak. Thus, as?Bloomberg News?points out, this creates quite the predicament for officials as they try and determine whose direction to follow: President Xi Jinping who emphasizes a need for zero Covid-19 cases, or Premier Li Keqiang who suggests officials should focus on boosting the economy to meet necessary growth targets?

After a 4.8% rise in Chinese GDP at the start of the year, the latest official data showed a contraction in industrial output for the first time since 2020. The jobless rate, meanwhile, climbed to 6.1% in April, a near record high, suggesting the latest policy measures including additional lockdowns may be undermining Q2 growth.?

Equity markets are struggling to recapture earlier losses in the week. Overnight equities in Asia closed higher with the Shanghai Composite Index rising 0.50% to close at 3,123.11.

In the U.S., equities were mostly flat overnight.

This morning, however, after a 0.60% rise yesterday, equities are trading higher with the Dow up 1.3% at 32,524.03 as of 10:01 a.m. ET.

Yields are trading lower with the 5-year UST yield down 4bps at 2.68% and the 10-year UST yield down 1bp at 2.74% as of 10:03 a.m. ET.

On the data front, yesterday, durable goods orders rose 0.4% in April, less than the 0.6% rise expected, according to?Bloomberg,?and the weakest pace in two months. Year-over-year, headline orders rose 9.9% in April, a two-month high.

Transportation orders rose 0.6%, following a 0.3% decline the month prior, thanks to a 4.3% gain in civilian aircraft orders. Vehicles and parts orders, however, fell 0.2%. Excluding transportation, durable goods orders rose 0.3% in April and increased 6.0% over the past 12 months.

Capital goods orders rose 0.7% in April. Nondefense capital goods orders, meanwhile, increased 0.4%, following a 0.5% drop in March. Capital goods orders excluding aircraft?and?defense – a proxy for business investment – climbed 0.3% in April, less than the 0.5% rise expected and following a 1.1% increase in March. Year-over-year, business investment increased 6.3%.

In other details, primary metals orders gained 0.6%, machinery orders rose 1.0%, and computers and electronics orders increased 0.1% in April. On the other hand, electrical equipment orders fell 0.1%, a three-month low, and fabricated metals orders also declined 0.1% in April following a 1.1% increase in March.

Bottom Line:?Durable orders rose less than expected in the latest April report. That being said, activity remains positive, suggesting businesses are still producing, growing, hiring and investing, a welcome sign for growth after a disappointing start to the year. Of course, going forward, further supply chain dislocations, ongoing labor supply shortage and a rising cost of capital –among others factors – will no doubt act as increased headwinds in the second half of the year. For now, however, producers continue to put forth a significant effort to meet a still positive level of demand in the marketplace.

This morning, GDP was unexpectedly revised down a tenth of a percentage point to a 1.5% decline an annualized basis in the second-round first quarter report, the first contraction since Q2 2020. According to?Bloomberg, activity in the first three months of the year was expected to be revised up to -1.3%.

In the details, personal consumption was revised up from a 2.7% gain to a 3.1% increase, a three-quarter high.

Goods consumption was revised up from a 0.1% decline to a flat reading, following a 1.1% rise in Q4, due to revisions in nondurable and durable goods consumption. Nondurable goods consumption was revised down from a 2.5% decline to a 3.7% drop. Durables consumption, however, was revised up from a 4.1% increase to a 6.8% gain, the largest increase in three quarters.

Services consumption, meanwhile, was revised up a half a percentage point to a 4.8% increase, up from a 3.3% gain the quarter prior.

Gross private investment, a gauge of business spending, was revised down from a 2.3% gain to a 0.5% increase in Q1, down from the 36.7% jump in Q4.

Fixed investment was revised lower from a 7.3% increase to a 6.8% gain in the first quarter, still the largest increase in a year.

Nonresidential investment, including office buildings and factories, was unrevised at a 9.2% increase, due to a downward revision in equipment investment from a 15.3% gain to a 13.2% increase, and an upward revision in intellectual property investment from an 8.1% increase to an 11.6% gain. Structures investment, however, was revised down from a 0.9% decline to a 3.6% drop, the fourth consecutive quarter of decline.

Additionally, residential investment was revised down from a 2.1% gain to a 0.4% increase, following a 2.2% increase in Q4.

On the trade side, exports were revised up from a 5.9% decline to a lesser 5.4% decrease, the largest decline since Q2 2020, while imports were revised higher from a 17.7% gain to an 18.3% increase.

Finally, government consumption was unrevised at a 2.7% decrease, following a 2.6% decline the quarter prior. Federal spending was revised down from a 5.9% decline to a 6.1% decrease, and nondefense spending was revised down from a 2.2% decline to a 2.6% decrease, while national defense spending was unrevised at an 8.5% drop, the fifth consecutive quarter of decline. Also, state and local spending was revised up from a 0.8% decline to a lesser 0.6% decline, following a 1.6% drop the quarter prior.

Bottom Line:?While the downward revision to first-quarter GDP was minimal, it was nevertheless a further downgrade of activity at the start of the year with an increased emphasis on corporate weakness. Of course, with a modest improvement in consumer activity January through March, this morning’s report no doubt reinforces the Fed’s notion that the weakness early on is not indicative of a lasting trend. After all, as of late, growth in Q2, for example, is expected to rise 3.0% according to?Bloomberg?estimates and 1.8% based on the Atlanta Fed’s GDPNow model. While somewhat lower than earlier consensus estimates, in either case, this is more than enough?“strength”?to keep the Fed’s foot on the gas at least through June.

Also this morning, initial jobless claims fell 8k from 218k to 210k in the week ending May 21, more than the decline to 215k expected, according to?Bloomberg?and a two-week low.

Continuing claims, however, or the total number of Americans claiming ongoing unemployment benefits, rose from 1.32M to 1.35M in the week ending May 14, a three-week high.

Additionally this morning, pending home sales dropped 3.9% in April, more than the 2.1% decline expected and the largest decline in two months. Year-over-year, pending home sales fell 11.5%, the fifth consecutive month of contraction.

Recall earlier this week, new home sales unexpectedly plunged, falling nearly 17% in April. This was not only larger than expected, but the decline left the pace of sales at 591K, just slightly above the previous pandemic low.?Year-over-year, sales are in the red, down 27%.

Finally this morning, the Kansas City Fed Manufacturing Activity Index fell two points to a reading of 23 in May, less than the expected decline to 15, albeit a five-month low. In the details of the report, new export orders rose from 4 to 8, the number of employees jumped from 19 to 34, and the average workweek increased to a reading of 13, a two-month high. On the other hand, prices paid fell from 83 to 72, production declined from 28 to 19, and shipments dropped 10 points to a reading of 17 in May, the lowest reading since January. Additionally, the six-month outlook fell from 34 to 31 in May, a five-month low.

Later today at 12:00 p.m. ET, Fed Vice Chair Lael Brainard will discuss digital assets before the House Financial Services Committee during a hearing on central bank digital currencies.

Tomorrow, the latest read on the Fed’s preferred measure of inflation, the PCE will be released. The headline is expected to slow to 6.2% in April from 6.6% and the core reading is forecast to cool from 5.2% to 4.9%.

Also tomorrow a check on the health of the consumer’s financial position with April income and consumption. While income and consumption remain in positive territory on a nominal basis, adjusting for inflation with the PCE up at a 40-year high, real consumption, has been slowing for the past eleven months, dropping from a peak of over 25% in April last year to 2.3% as of last month. Consumption is expected to slow further in April to a 0.7% gain. Real income, meanwhile, has fallen deep into negative territory, down over 17% on an annual basis. In April, nominal income is expected to rise 0.5%, down 0.3% after adjusting for inflation.?

-Lindsey Piegza, Ph.D., Chief Economist