submitted by
Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast
The U.S. economy grew more than expected during the second quarter of this year. The BEA released preliminary estimates of GDP and it showed that the nation’s economy grew at 2.4%, exceeding the consensus estimate of 2%. Consumer spending was the largest driver of growth, contributing 1.12 of the total 2.4% growth. Spending on services was the primary driver of consumer spending, exceeding the contributions from goods spending. The economy imported more goods than exported, subtracting from the overall GDP growth. On the investment component of GDP, non-residential investment was the largest contributor of gross private domestic investment, specifically, investment in equipment and structures. Residential investment contributed negatively to the overall change in GDP. Government investment also contributed favorably to growth, with local and state government spending contributing the most. The GDP report was a boost to the idea of a soft landing. Even though the GDP report is a look at the economy through the rear-view mirror, it provided further evidence that the economy is inching toward the so-called soft-landing scenario.
The big news from the past couple of weeks was out of the Fed and the Bureau of Labor Statistics. The Fed announced another increase in the targeted Fed Funds rate to 5.25%. This increase was largely expected, but followers were more interested in Fed statements and of Jerome Powell for clues on subsequent rate hikes. The CME Fed Watch Tool now places an 80% probability of no change in rates at the next September FOMC meeting, and a 20% probability of a quarter percent hike. All this will rest on data over the next couple of months, with a greater focus on inflation indicators and the labor market.
Markets and the Federal Reserve did get some reassurances about inflation with the release of two recent price reports: the CPI and PCE price index. First, the Consumer Price Index (CPI) declined to 3%, down from the prior month of 4%. The core rate, CPI minus food and energy, came down to 4.8%, from the prior month of 5.3%. The monthly changes for both the headline CPI and the core rate came in under the market consensus. The monthly change of .2% in the headline CPI is consistent with an annual rate of 2.4%. As we’ve mentioned on these pages, the rate of inflation is coming down, and the CPI report provided a significant boost to that argument. The Fed’s preferred gauge on inflation, the PCE Deflator, showed additional disinflation in both the headline rate and the core. The headline rate declined to 3% and the core moderated to 4.1%, down from the prior month of 4.6%. The quarterly Employment Cost Index (ECI) was also released the same day as the PCE Deflator, and it too showed moderation in employment costs, providing additional support for moderating inflation.
While still above the Fed’s preferred inflation target of 2%, the past two weeks provided additional data in support of moderating inflation. We will likely not see a rate increase in September, or the rest of this year. The July rate increase may be the last. If the last quarter sees a significant slowdown in the labor market, either through a higher unemployment rate or a reduction in monthly job creation, the Fed could even begin reducing interest rates later this year. I think that scenario is highly unlikely, however. The labor market remains tight, and employers are reluctant to let go of employees. Unemployment claims are not pointing to any labor market slowdown, and households have been quite resilient, providing support to overall growth. No recession for this year, and moderating prices, along with a tight labor market, will continue to pave the way for a soft landing.
This Friday is the Super Bowl of economic indicators, the national employment report. Payroll gains have moderated from last year but are still above historical monthly gains. In the past couple of years, we’ve observed that “good news” reports resulted in negative stock market reactions due to the impact on Fed Reserve interest rate changes. A “good news” report implied that the Fed would have to increase rates to slow down the economy and temper inflation. “Bad news” reports had the opposite effect. A “bad news” report produced a positive stock market reaction. If we see a strong report this Friday, it may produce a positive reaction in the markets. A strong report will provide further support for no recession, and as inflation continues to moderate, the markets will place greater emphasis on growth, over the Federal Reserve’s impact on interest rates.
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