The first quarter of 2024 has largely maintained the momentum of Q4 within the financial markets. Much of this seems to be related to enthusiasm surrounding guidance the Federal Reserve has provided that they are done with raising interest rates, and are hoping to being lowering rates at some point in 2024.
This focus on the actions of the Federal Reserve has become a familiar theme since they embarked on this most recent interest rate hiking campaign. At the beginning of the year, markets were pricing in expectations of rates being lowered beginning in March. As March came and went, the focus turned towards a potential hike in June. And, with recent inflation data coming in stronger than many had hoped, expectations have now been pushed later into the year.
Why are these expectations continually being pushed back? The answer is two-fold: inflation data is having a hard time getting back to the Fed’s 2% target, and economic growth has largely held up, in defiance of many a predicted slowdown.
Through the first three months of the year, we have seen inflation seemingly start to accelerate again. Inflation had reduced down to around 3% year-over-year near the end of 2023, but has since rebounded to 3.5% as of the March reading. On top of this, some of the shorter term measures of inflations (such as 3-month and 6-month views) are showing even higher levels which could signal more inflation to come. The Fed is suggesting these are just “bumps” in the road down to 2% inflation. Let’s hope they are correct, because the markets clearly expect to benefit from being able to lower rates in the near future.
The second reason interest rate hikes are being pushed further out is the continued growth of the overall economy. We’ve had two consecutive quarters of 3%+ growth in GDP, and estimates for the first quarter of 2024 are in the mid 2% range. Federal government spending is continuing at a mind-boggling pace, having hit $1 trillion deficit in just the first 6 months of the fiscal year. While retail sales slumped a bit early in the quarter, they have since rebounded to close to 4% year over year growth as of the latest March numbers (with prior February estimates being revised upward). This suggests that while much of consumer spending growth is related to inflation, the consumer spending growth is slightly outpacing inflation. On the manufacturing front, while still operating at relatively low levels, we saw the ISM manufacturing index move into expansion territory for the first time in 16 consecutive months.
This is all good news, but we also still have reasons to be cautious about what is ahead. Unemployment, while still at very low levels, has clearly been on the rise over the past year, rising from 3.5% to 3.8%, currently. Real estate and housing markets are still struggling with the higher interest rate environment. The largest contributors to job growth over the last year continue to be government and healthcare jobs, both of which tend to reflect dynamics that are not necessarily associated with normal economic activity and maintain or grow even during downturns. At the same time, the globe seems to be on fire with multiple geopolitical disputes that have the potential to create much wider fallout. This includes disputes between Russia-Ukraine, Israel-Hamas, Israel-Iran, China-Taiwan, and even instability in various countries in South America.
In sum, we are still seeing quite a dichotomy of data and perspectives about where the economy and ultimately markets are going. To us, that calls for caution, being prudent, and making sure that we are hedging for the potential of various outcomes to come to fruition. As we get later into the year, more of the focus will be consumed by the US Presidential Election. But, for now, it is still all eyes on the Fed. We don’t believe this focus on the Federal Reserve’s actions is healthy, and we would love to see more of a focus back on economic and investing fundamentals. In the meantime, we have to invest in the world we are given, not the world we wish it to be. With that, expect to see markets reacting to news and Fed comments that seem to provide insight into the next action the Fed plans to take.
Federal Reserve Policy. The Fed maintained its current Fed funds rate at 5.25% - 5.50% during the quarter. They signaled they are done hiking and are looking to lower rates as soon as the data provides them the space to do so. They have also signaled they may begin to slow down their quantitative tightening (runoff of their asset portfolio) in the near future.
Economic Growth – GDP. GDP grew at 4.9% in Q3 and 3.4% in Q4 of 2023 based on the 3rd estimates. Q1 GDP is projected to come in a bit softer with many predicting growth in mid 2% range. Others have been increasing their full year 2024 forecasts.
Labor Markets. Unemployment ticked up slightly to 3.8% during Q1. Labor Force Participation rate held at 62.5% for most of the quarter but jumped to 62.7% as of the latest reading. Job openings continue to outnumber job seekers, with the latest figure at approximately 8.75 million as of February. We’ve continued to see growth in jobs, and have not seen a substantial slowdown in the monthly readings.
Inflation. Inflation has improved substantially in the last year, but still runs higher than the Fed’s target. The headline CPI figure has started to reaccelerate, hitting 3.5% as of March. The Fed’s preferred gauge (Core PCE) is 2.8% year-over-year. Shorter-term figures also suggest reacceleration, and the markets have largely paused the rally in light of this trend.
Consumer Sentiment & Spending. Personal consumption and retail sales have maintained positive trajectories, although they are largely flat in real terms over the previous two years. Spending took a hit early in the quarter with fairly negative reports in both January and February, but bounced back with the March report. This will be a key data point to watch in the coming months.
Housing & Real Estate. Real estate markets were savoring the prospect of rates being lowered, and have had to swallow tough news on that front over the past couple of months. This is likely to be a slow, tough slog for the industry. National Association of Realtors also just agreed to a landmark settlement which has the potential to change how the residential real estate market operates. How this ultimately affects the overall market is difficult to decipher, but some are predicting close to 50% of the agent workforce may be eliminated with these changes.
Business Investment & Manufacturing. Manufacturing finally went into expansion based on the latest ISM Manufacturing reading. This is welcome news after 16 consecutive months of contraction. We’ll have to see if this is an aberration or the beginning of a trend. There is still a lot of spending in this area, and the federal government is full throated behind the “green” energy transition. Can it sustain the high interest rates?
Global Economy. Inflation is moderating and central banks have begun discussions about when and how quickly they should lower their interest rates. However, geopolitical tensions continue to rise. Progress in inflation and other areas are threatened by this. Recently, a new front in the global chaos has opened between Israel and Iran. Prior to the past couple of weeks, Iran has always used proxies to go after Israel. Now they have erased that line and directly attacked Israel for the first time. The Russia-Ukraine conflict seems to be largely frozen, but Russia is trying to take advantage of delays in Western aid to Ukraine. These events can spiral quickly, and it is not hard to see the contours of a WWIII situation and the resulting implications on economies around the world. Let us all hope that cooler heads prevail and avoid the worst of these outcomes.