Macro Market Notes Digest - June 2024

Welcome to the June digest of posts published on Macro Market Notes in 2024! I do publish summaries of blog posts on LinkedIn or Twitter right after I publish one, but this newsletter is another way to keep informed about my publications on Macro Market Notes or elsewhere.

In June I wrote about the May jobs report, the June FOMC meeting, as well as the state of consumption, excess savings and core PCE inflation in May. And as per usual I finish with some final thoughts.

If you have feedback on any of the pieces outlined below, let me know in the comments or message me. Also feel free to reach out if you want to chat about a particular topic or if you know of professional opportunities that could be of interest to me.

The Monthly Digest

May Payrolls: A Hodgepodge Labor Market (June 7th)

A summary of this post was featured on LinkedIn News: Payrolls popped by 272K in May

Key takeaways:

• Payrolls growth momentum picked up and trends continue to run above the breakeven pace needed to keep the unemployment rate constant.
• The unemployment rate hit 4% as the labor force participation rate dropped from 62.7% to 62.5%. The immigration impulse on labor supply is now past its peak and is clearly fading at this point.
• The job-finding rate fell over the month to below 50% but smoothed trends remain around 50%, a level were entries and exits in and out of unemployment are broadly balanced.
• Wage growth rose, with momentum in composition-adjusted average hourly earnings turning away from the pace consistent with 2% inflation.
• Today’s data will not sway the Fed’s focus away from the inflation data to determine the start date of rate cuts.

June FOMC Meeting: Ready for Take Off? (June 12th)

A summary of this post was featured on LinkedIn News: Fed sees one rate cut this year

Key takeaways:

• The FOMC decided to keep the Fed funds target rate unchanged at 5.25%-5.50% and signaled a bias to keep rates on hold for now.
• Underlying inflation remains stable at above-target levels, at around 2.8% PCE inflation.
• Although the labor market remained relatively strong, household wage income growth has slowed recently to a pace that could over time push spending in line with 2% inflation.
• Expected near-term real interest rates remain in line with the Fed’s own assessment of its stance.
• As the expected year-ahead real rate path remains restrictive and real economic activity levels remain strong, the FOMC will continue to be patient and wait for sustained weakening in inflation data before deciding to cut policy rates.
• Trends in underlying inflation suggest Fed funds rate cuts likely will start at the September FOMC meeting. However, conditional on solid real activity AND disagreement in the FOMC regarding the restrictiveness of its policy, the Fed will be very cautious when cutting rates, especially this year.

May Personal Income & Outlays: Good News (June 28th)

A summary of this post was featured on LinkedIn News: Inflation slows to three-year low

Key takeaways:

• Personal income growth out of wages and salaries picked up in May. This meant that household wage income growth runs slightly above the pace that’s broadly consistent with 2% PCE inflation over the medium-term.
• The stock of excess savings has NOT run out and continues to be a tailwind for consumption. Between April and May, it fell around $22 billion and equaled about $477 billion in May.
• Going into Q2 2024 headline consumption growth accelerated moderately above underlying spending growth and even beyond Q2 the above-2022 pace of underlying consumption growth does not signal that a large downshift in consumption is forthcoming
• Core services excl. housing PCE inflation, the Fed’s favorite gauge of underlying inflation, remains at elevated levels but continued to show a slowing in momentum. The central tendency of PCE inflation currently suggests underlying inflation at around 2.8%.
• Although underlying inflation still remains above the 2% inflation target, momentum in these measures is slowing such that it makes a September rate cut possible. But strong wage income and underlying consumption growth rates suggests that the Fed will likely be patient and prefers to start rate cutting towards the backend of the year.

Final Thoughts

Fed officials came out of their June FOMC meeting emphasizing caution when it comes to inflation. And you can't really blame them, as since November-December they witnessed a firming in inflation for almost six months while inflation rates still were squarely in above-target territory. Reasons put forward for this firming have been ranging from residual seasonality to continued labor market strength feeding elevated spending growth.

No matter the reason, a consequence of the continued inflation overshoot relative to the 2% inflation target has been that across a variety of consumer and firms' inflation expectation surveys throughout April and May these expectations rose, and remained stable at elevated levels in June. This was reflected in my estimate of the common trend across these surveys I circulated earlier in June. Last Friday's release of the final results of the June University of Michigan Survey did not materially change this estimate (chart above) although the June estimate got revised down somewhat in line with that survey. The chart above makes clear that in response to the inflation firming earlier in the year inflation expectations moved up in Q2.

Furthermore wage increases continued to outpace the growth rate consistent with 2% PCE inflation in the medium term. The green and blue lines in the chart above combine the following three elements, i.e.,

1. The trend productivity growth estimate described earlier (assuming a Q1 trend labor productivity level equal to the trend labor productivity change for the preceding quarter, followed by linear interpolation from the quarterly to the monthly frequency).
2. A similar estimate of trend labor share growth (assuming a Q1 share level based on the trend labor share estimate for the previous quarter, followed by linear interpolation from the quarterly to the monthly frequency).
3. And, either the year-ahead inflation expectation proxy based on the common factor from firm and household surveys or the 2% inflation target.

The sum of 1-3 above will result in two alternative trend wage (W*) measures. The chart above makes clear that properly adjusted wage data from the May job report continues to grow faster than what would be consistent with 2% inflation. Instead we notice that the earlier discussed developments in inflation expectations appear to lay somewhat of a floor underneath wage growth well above that inflation target wage growth pace. And as actual wage growth continues to outpace inflation expectations as well, real wage income growth remains a boost for household spending and thus economic activity.

So while the May PCE data could be seen a first sign that disinflation might be returning, Fed officials have made clear in public statements they want to see evidence of 'sustained disinflation' before they're prepared to ease policy. With some Fed officials referring to 'quarters' of inflation progress it is most likely the case that the Fed is not prepared to cut policy rates until underlying PCE inflation hits 2.5% or less at an annualized six-month basis. If we continue to see weak monthly inflation numbers this summer this might mean a rate cut is possible at the September FOMC meeting. But this is a big "if" and with consumption spending and labor market data remaining strong, the Fed likely is going to be very patient in determining the start date of cutting cycle, especially as there's clear evidence of disagreement within the FOMC about the degree of restrictiveness of the Fed's policy stance. Barring evidence of an economic slowdown this year more severe than what the Fed projected in its June SEP projections, I think it is more likely that cuts would happen towards the backend of the year.

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