Macro Market Notes Digest - May 2024

Welcome to the May 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 May I wrote about the May FOMC meeting, the Q1 productivity and costs data and what it implied for the Q1 ECI wage data, the April jobs report, as well as the state of consumption, excess savings and core PCE inflation in April. 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 FOMC Meeting: Holding Off ... Again (May 1st)

A summary of this post was featured on LinkedIn News: Fed sees stubborn inflation

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 several meetings. Additionally, QT will be tapered starting in June with the cap on Treasury redemptions dropping from a monthly $60 billion to $25 billion.
• Underlying inflation no longer points to continued substantial disinflation going forward, while near-term “Main Street” inflation expectations bottomed in Q1 2024.
• The labor market, wage growth and consumption spending remain relatively strong.
• Since the March FOMC meeting, expected near-term real interest rates have been 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 more progress in inflation data as well as labor market trends before deciding to cut policy rates.
• Trends in underlying inflation suggest Fed funds rate cuts now likely do not to start until the September FOMC meeting, with the June FOMC meeting likely being used to signal a lower total amount of rate cuts on the back of a notable upgrade in the Fed’s own neutral rate estimate.
• However, if by the September FOMC meeting the data trends are still such that it remains hard for the Fed to embark on rate cuts, I do believe the Fed will take the current easing bias off the table and raise the possibility a recalibration towards a more restrictive policy stance might be needed beyond that meeting.

Q1 Productivity & Wages: Still Below Trend (May 2nd)

A summary of this post was featured on LinkedIn News: Job market tougher than it looks

Key takeaways:

• Over the quarter labor productivity was weak in Q1, and labor productivity stalled below its trend estimate. Base effects resulted in an acceleration in year/year growth.
• The pace of trend labor productivity growth, which was 1.3% year/year in Q1, remains below an average trend labor productivity growth rate of 1.9% year/year in 2019.
• The labor share went up over the quarter and caught up with its trend estimate, which is estimated to be -0.7% year/year in Q1 compared to an on average flat trend labor share estimate for 2019.
• The Q1 ECI index for wages of private sector workers went up 4.3% year/year. This is about 1.6 percentage point above the wage growth rate consistent with 2% inflation given the trend growth rates of labor productivity and the labor share.
• The Q1 overshoot in ECI wages of private sector workers was driven by above trend year/year labor productivity growth, mostly owing to base effects, and still relatively elevated near-term inflation expectations of firms and households.

April Payrolls: What A Nice Easter Egg (May 3rd)

Key takeaways:

• Payrolls growth momentum slowed but trends continue to run above the breakeven pace needed to keep the unemployment rate constant.
• The job-finding rate stabilized around 50%, a level were entries and exits in and out of unemployment are broadly balanced.
• Wage growth slowed notably, with momentum in composition-adjusted average hourly earnings turning closer towards the pace consistent with 2% inflation.
• Today’s data allows the Fed to focus on progress in inflation data to determine the start date of rate cuts.

April Personal Income & Outlays: Some Progress (May 31st)

Key takeaways:

• Personal income growth out of wages and salaries slowed in April and was notably revised down for Q4 2023 and Q1 2024.
• With these revisions household wage income growth now has slowed to a 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 March and April, it fell around $29 billion and equaled about $523 billion in April.
• Core services excl. housing PCE inflation, the Fed’s favorite gauge of underlying inflation, remains at elevated levels but showed some slowing in momentum. More boarder based underlying inflation measures accelerated since late 2023 further above the Fed’s inflation target. The central tendency of PCE inflation currently suggests underlying inflation in the 2.8%-3% range.
• Although underlying inflation remains stubbornly stuck above the 2% inflation target, slowing wage income growth suggests that over time spending will likely bring about more slowing in core services inflation. Given this, the Fed will be patient and is unlikely to cut rates this summer.

Final Thoughts

Fed officials have expressed disappointment in their public statements since the May FOMC meeting in the pace of inflation. As I pointed out earlier here on LinkedIn, short-term interest rates, adjusted for near-term inflation expectations, appear restrictive compared to a range of R* estimates (see also chart below). While rates have been restrictive since summer 2023, the Fed may need to maintain its current stance longer to achieve a return of inflation towards its 2% target.

Continued inflation overshoots could negatively impact inflation expectations. Indeed, a variety of consumer and firms' inflation expectation surveys for April and May reported rises in near-term inflation expectations.

I do quantify the common trend across these "Main Street" inflation expectations. The update of this estimated common trend I circulated earlier this month incorporated most of the aforementioned updates. Since then, however, the Conference Board also published its May Consumer Confidence indicator, and the chart above incorporates these as well. Bottom line is that since disinflation lost its momentum in Q1 2024 we've observed a tick up in the common trend across "Main Street" near-term inflation expectations.

When we cast away the most volatile components of inflation, the chart above makes clear that despite some inflation easing in April underlying inflation rates remain stuck in the 2.8%-3% range. Combined with inflation expectations that are creeping higher it suggests that the recent leveling off of disinflation is more broad-based then many commentators would like to admit. And the longer this lasts, the more it will erode the restrictiveness of current interest rate levels, undermining the Fed's "high for long" strategy.

One positive development for the Fed is that labor market normalization appears that have had an impact on wage income growth of households. With growth of the most important component of consumers' incomes slowing in line with a pace that over time is consistent with the 2% inflation target, there's prospect that consumer spending could cool just enough over the next quarter to induce further easing in core services inflation.

The Fed likely will continue to signal that they will stand pat for the time being and attempt to further temper expectations of aggressive rate cuts. Their hope is then that a further income cooling owing to labor market normalization will gradually bring about more disinflation momentum in the services categories of consumer prices. Patience and "high for longer" will remain the cornerstones of Fed policy for the time being. Do not expect any rate cuts before Labor Day.

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