The Fed Speaks

by Hubert Marleau, Market Economist, Palos Management

May 10, 2024

The data docket was sparse this week, but a cast of Fed officials expressed publicly their outlook for the economy in terms of inflation and growth and their view of monetary policy. It is the usual practice for these monetary officials to do so the week following FOMC meetings as their blackout period is over. Based on last week’s Fedspeaks, there appears to be unanimity that it will take longer to get inflation back under control, having pointingly said that interest rates aren’t coming down anytime soon.

Richmond Fed President Barkin said: “I’m optimistic that today’s restrictive level of rates can take the edge off demand in order to bring inflation down to our target and if the economy slows significantly, the Federal Reserve has enough firepower to support it.” He added that he does not believe the economy is overheating, justifying a go-slow approach on interest rates (courtesy of Market Watch).

Boston Fed President Susan Collins said: “A slowdown in activity will be needed to ensure that demand is better aligned with supply for inflation to return durably. The recent upward surprises to activity and inflation suggest the likely need to keep policy at the current level until we have greater confidence that inflation is moving sustainably toward 2%”(courtesy of the Federal Reserve Bank).

Minneapolis Fed President Neel Kashkari said; “While there are several scenarios one could contemplate, the most likely scenario is where we are right now, which is just we stay put for an extended period of time until we get clarity on whether disinflation is, in fact, continuing or if it has stalled out.”

San Francisco Fed President Mary Daly said: “There is considerable uncertainty about where inflation is headed in the coming months. We’ve had 3 stubborn months of data, but I still see monetary policy is working. I do think that we’re seeing, in a really positive way, disinflation. I’m in a wait and see mode” (courtesy of Macro Strategy Partnership). She also noted that many companies were losing pricing power. This may be connected to a “trade down on price” by consumers, who are eager to save money by turning to cheaper goods and services. Adobe Analytics and Amazon have confirmed that an online shift to low-priced goods is taking place, reshaping spending patterns in personal care, electronics, apparel, home stuff, furniture and, yes grocery.

Chicago Fed President Austan Goolsbee said he sees inflation continuing to come down in 2024, without a recession, implying a so-called soft landing for the U.S. economy.

New York Fed President John Williams said that at some undefined point the central bank will cut rates - “Eventually we’ll have to cut rates” but for now monetary policy is in “a very good place”. He did not offer any timetable, but said the economy was moving into a better balance amid a shift to a slower rate of growth. He expects the economy to grow between 2% and 2.5% this year (courtesy of MacroStrategy Partnership).

If indeed the economy is to grow with less inflation, then further productivity gains will be needed. Perhaps this is exactly what is going on, making concerns about the economy misguided. The Atlanta Fed’s NowCasting Model real growth estimate for Q1 is 4.2%, and yet total hours worked in April was at 0.9% less than the average for Q1. Meanwhile, initial jobless-benefit claims were up 22,000 in the week May 4 to 231,000 suggesting the number of unemployed people in the workforce, which was up 10.4% in March from a year ago, is still rising. This points to solid productivity gains.

Conversations with industrial CEOs at the International Economic Forum have confirmed a productivity lift is underway, which is due to technology-related adjustments to how workers do their job. For now, they are not yet fully driven by generative AI, but they insist that it’s coming. The WSJ’s Ray A. Smith and Lauren Weber reported that AI tools like ChatGPT and large language models (LLMs) are taking out a lot of time consuming, daily-grind, grunt-work in a number of white-collar fields, from medicine and law to marketing and accounting. In a report, McKinsey estimates that in the US, generative AI could account for 8% of work hours being automated by 2030. Goldman Sachs sees an even larger impact, citing electric motors and personal computing as breakthroughs leading to labour productivity of 1.5% per year over the next decade.

Thus what is stoking optimism in stocks is not based on the ridiculous and inexplicable aptitude for the market to rally on 2 opposite narratives. A landing will lower rates or a no-landing will bring higher profits, making bad and good news bullish: it’s the pairing of growth and lower inflation, which is generated by an upward turning point in productivity, bringing higher corporate profits. Consensus analyst expectations for the S&P 500 earnings per share edged up for both 2024 and 2025 to yet another record high as corporate managements continue to provide upbeat forward guidance. As a matter of fact, a notable increase in actionable buys by insiders and buybacks have already occurred, particularly in cyclical groups such as trucking, airlines, tech, energy, steel, gaming, car rental, industrials and regional banks.

Meanwhile, the S&P 500 reclaimed record territory, closing at 5223, after registering a weekly gain of 3.7% or 188points. Although 5265 is a key resistance level followed by 5390 with major support at 4950, Barron’s latest Big Money poll revealed that only 15% of the respondents were bearish. Market optimists had a mean forecast of 5461, with hardly any premium (concern) for political risk. According to Ernie Tedeschi, with the YALE Budget Lab and former White House Council of Economic Advisers, using data from NYU Stern economist Aswath Damodaran, only a few countries (US, Canada, Australia and Switzerland) enjoy zero risk premium, meaning investors do not demand any extra compensation for deploying capital in these countries.

Doug Ramsay at Leuthold believes: “another 10% increase in the S&P 500 is not out of the question. Based on 80 years of data on bull-market rallies, focusing on those that happened when unemployment was this low and the economic cycle this mature, it could end as high as 5705 by the end of the year, if the current rally meets the prior records for length and level” (courtesy of Bloomberg).



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