Economy Slowing, Fed Should Be Patient

Stocks opened higher today despite weaker macro data (see below). Currently, the Dow is up 308 points and the S&P 500 is up 1.25%. Of the eleven market sectors, only energy and healthcare are sitting out today’s rally. Bonds are selling off again as interest rates float a bit higher. We’re watching the 2-year Treasury note yield, which dips as recession fear rise and rises as they subside. The 2-yr yield has been rising since April 5th.

The US economy grew less than many economists expected in the first quarter. Gross Domestic Product (GDP) grew 1.1% from the prior quarter (annualized), and 1.6% from the year-ago quarter. Digging into the numbers, the reason for the miss was a sharp decrease in business investment and inventories. CEOs are becoming cautious. On the other hand, consumer spending was significantly stronger than expected, rising 3.7%. So it’s the same old narrative: the job market is strong and wages are rising, so consumers can afford to spend. Bloomberg economist Eliza Winger says this report “dispels recession fears for now.”

So maybe it’s not a surprise that inflation is a bit sticky. The GDP Price Index ticked up to 4.0% from 3.9% in the prior quarter. Of course, the Federal Reserve is paying attention. They view the economy’s resilience and inflation’s stickiness as a problem—or at least evidence that more monetary tightening is necessary. Many investors think this GDP report makes another .25% interest rate hike a certainty. The bond market has already built-in that expectation.

But while the economy has proven more resilient in the face of higher interest rates than many anticipated, a slew of recent surveys by various Federal Reserve banks show that business activity is softening. The Philadelphia Fed’s Non-Manufacturing Activity survey, the Richmond Fed Business Conditions Index, Dallas Fed Services Activity, and Kansas City Fed Manufacturing Activity Index all point to a weaker economy. So it is obvious that the Fed is accomplishing its mission and shouldn’t be too zealous about raising interest rates further. Patience is called for.