by Hubert Marleau, Market Economist, Palos Management
June 29, 2024
The Fed’s preferred inflation gauges - headline and core Personal Consumption Expenditure Indices - came out on Friday morning after a batch of shaky data during the past week, including slowing personal spending and wobbly signs in the job market. These 2 key economic measures slowed in May to 2.6% year-over year, the slowest annual rate in 3 years. The Atlanta Fed's GDPNow tracking model estimate for Q2 of 2024 was 2.2% on Friday, down from 2.7 % on June 22 and 3.1% on June 15.
As a result, traders in federal-funds futures now believe that there is a 70% chance of at least 2 interest rate cuts before the end of the year, because they foresee that in one year's time inflation will run in their judgement around 1.6%. Meanwhile, on Friday the S&P 500 touched 5023 early on, a new all-time high; but ended with a whimper as the media sparked concerns about the vitality of Biden and questions about the honesty of Trump mounted.
Interestingly, Larry Summers, a renowned critic of economic issues along with a few other luminaries has publicly articulated that Fed officials and investors are wrong about the path of inflation and, in turn, too optimistic about forthcoming interest rates, asserting that the pace of disinflation would have been much slower if it had not been for immigration, which had bloated the labour supply, and for the speed with which the supply of oil had adjusted to the conflict in Ukraine and the Middle East.
Assuming that the aforementioned factors have indeed played out, the magnitude of the bloated budget and current account deficits suggest that the twin deficits could foster rapprochement in the marketplace. According to Deutsche Bank, the weighted sum of the current account and budget deficits as a percent of GDP is -18.6%, by far the highest in the world among developed countries. By way of comparison, it’s -14.9% in the UK, -9.6% in Italy, -9.4% in France, -5.3% in Japan, -3.3% in Canada, 7.2% in Germany, 11.2% in Sweden and 15.0% in Switzerland. Curiously, Canada, Sweden and Switzerland have recently cut their policy rates.
There is little doubt in my mind that fiscal challenges of the U.S. are troublesome. Yet the USD is sitting pretty high at 106, versus 90.0 3 years ago. While I recognise that this success is somewhat related to the fact that the Fed has not succumbed to temptation to ease its monetary stance, I think that it has a lot more to do with American exceptionalism. The thing is that the U.S. is a very dynamic society, unmatched by other nations.
Its inherent capability to create productivity is enormous because it keeps on developing new technologies, integrating immigrants and generating wealth on a staggering scale. Even Larry Summers admits that the economic potential of the U.S. is second to none because it's heading for a period of really profound technological change and progress. More money and capital is flowing into the U.S. privately than the amount that is officially sold by objectionable central banks.
The dollar story is about the United States’ economic strength, the Fed’s independence and the private sector’s encouragement of entrepreneurship and creative destruction - i.e technology.
Copyright © Palos Management
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