Fed Policy, Inflation, Labour and Growth
US economy to grow slower, inflation to ease gradually, Fed's 2% target challenging, labour market to cool, housing market subdued.
Friday, August 2, Week 31
The US Dollar: Riding the Waves of Uncertainty
This report provides a comprehensive analysis of the current macroeconomic landscape of the United States, tailored specifically for forex traders. It delves into the intricate interplay of fiscal policy, economic indicators, and monetary policy, offering insights into recent developments and potential future trends. The report examines the performance of key economic indicators, the Federal Reserve's policy stance, and the potential impact of global economic headwinds. By understanding these dynamics, forex traders can make more informed decisions and capitalise on emerging opportunities in the currency market.
Steering Through Fiscal Policy
The US fiscal policy landscape is dominated by a substantial and growing budget deficit. In 2023, the deficit reached 6.30% of GDP, a significant increase from the historical average of -2.57%. This trend is expected to continue, with Trading Economics forecasting a deficit of -6.00% of GDP by the end of 2024. The recently passed Fiscal Responsibility Act of 2023, enacted in June, aims to address this issue by implementing spending cuts and increasing revenue through measures such as closing tax loopholes and enhancing IRS enforcement. However, the effectiveness of these measures in curbing the deficit remains to be seen.
The newly elected government's policies are also expected to play a significant role in shaping the fiscal outlook. The current administration's focus on reducing the deficit through spending cuts and increased tax revenue could impact economic growth and, consequently, the US dollar's valuation. The government's spending plans for key areas such as infrastructure, healthcare, and defence will be closely watched by market participants. Additionally, any potential changes to the tax code, particularly those affecting corporations and high-income earners, could impact investor sentiment and influence capital flows.
The Economic Compass: Navigating Mixed Signals
The US economy has presented a mixed picture in recent months, with signs of both strength and weakness. While economic activity expanded at a solid pace in the first half of 2024, concerns about a potential slowdown have emerged. The second quarter GDP growth rate came in at a robust 2.8%, exceeding market expectations, driven by strong consumer spending and a rebound in private inventory investment. However, the July jobs report painted a less optimistic picture, with nonfarm payrolls increasing by only 114,000, significantly below forecasts of 175,000. The unemployment rate unexpectedly rose to 4.3%, the highest since October 2021, and wage growth slowed.
These mixed signals have created uncertainty about the economy's trajectory. The Atlanta Fed's GDPNow model, a real-time tracker of economic growth, currently forecasts a 1.2% annualised growth rate for the third quarter. The Conference Board's Consumer Confidence Index, a key gauge of consumer sentiment, fell to 66.4 in July, the lowest in eight months, reflecting concerns about the labour market and rising prices. The ISM Manufacturing PMI, a measure of factory activity, contracted for the fourth consecutive month in July, falling to 46.8, indicating a slowdown in the manufacturing sector.
The Fed's Tightrope Walk: Inflation vs. Growth
The Federal Reserve faces a delicate balancing act as it navigates the current economic landscape. The central bank's dual mandate is to promote maximum employment and price stability. While the labour market remains strong, inflation has eased over the past year but remains above the Fed's 2% target. The Fed has maintained its target range for the federal funds rate at 5¼ to 5½ percent since June, after a series of aggressive rate hikes to combat inflation.
Market expectations regarding future monetary policy actions have shifted in recent weeks. Following the weaker-than-expected July jobs report, markets are now pricing in a 50 bps cut and two 25bps cuts in the three remaining FOMC meetings this year. This suggests that the market believes the Fed will need to ease monetary policy to support the economy as it slows. However, the Fed has emphasised that it will carefully assess incoming data and the evolving economic outlook before making any adjustments to its policy stance.
The Road Ahead: Macroeconomic Outlook
The US macroeconomic outlook remains uncertain, with both upside and downside risks. The economy is expected to continue expanding, but at a slower pace than in 2023. Inflation is projected to moderate further, but the Fed's ability to achieve its 2% target without triggering a recession remains a key concern.
Top Three Risks to the Outlook:
Sticky Inflation: Persistent supply chain disruptions, geopolitical tensions, and strong consumer demand could keep inflation elevated for longer than anticipated. Key developments: (a) The ongoing war in Ukraine continues to disrupt global energy markets. (b) The US-China trade war shows no signs of abating. (c) The June CPI report showed a 0.3% increase in core inflation, exceeding market expectations.
Hard Landing: The Fed's aggressive monetary policy tightening could trigger a sharper-than-expected slowdown in economic activity, potentially leading to a recession. Key developments: (a) The July jobs report showed a significant slowdown in job growth and an unexpected increase in the unemployment rate. (b) The ISM Manufacturing PMI has been in contraction territory for four consecutive months. (c) Consumer confidence has declined in recent months, reflecting concerns about the economy's future.
Global Slowdown: A slowdown in global economic growth, particularly in China and Europe, could negatively impact US exports and overall economic activity. Key developments: (a) The Chinese economy is facing headwinds from a property market slump. (b) The Eurozone economy is struggling with high energy prices and supply chain disruptions. (c) The International Monetary Fund has downgraded its global growth forecast for 2024.
Action Points for Forex Traders:
Monitor incoming economic data releases, particularly inflation and labour market indicators, for signs of a potential shift in the Fed's policy stance.
Pay close attention to the upcoming FOMC meetings on September 17-18 (Tuesday-Wednesday, Week 38) for clues about the Fed's future policy trajectory.
Monitor global economic developments, particularly in China and Europe, for potential spillover effects on the US economy.
Economic Indicators: Gauging the Economic Pulse
Economic Growth:
Real GDP: Increased at an annualised rate of 2.8% in Q2 2024. The Atlanta Fed's GDPNow model currently forecasts a 1.2% growth rate for Q3.
Industrial Production: Rose 0.6% month-over-month in June. Capacity utilisation remains below its long-run average, suggesting room for further growth.
Price Changes (Inflation):
CPI: Increased 3.0% year-on-year in June, the lowest since June 2023. Core CPI rose 3.3%, a fresh low since April 2021.
PCE Price Index: Increased 0.1% month-over-month in June. Core PCE inflation held unchanged from the prior month at 2.6%.
Labour Market:
Nonfarm Payrolls: Increased by 114,000 in July, significantly below market expectations.
Unemployment Rate: Rose to 4.3% in July, the highest since October 2021.
Average Hourly Earnings: Increased 0.2% month-over-month in July. Wage growth has slowed in recent months.
Housing Market:
Housing Starts: Rose 3% month-over-month in June, rebounding from a decline in May.
Existing Home Sales: Fell 5.4% month-over-month in June, the sharpest monthly decline since 2022.
Case-Shiller Home Price Index: Increased 6.8% year-on-year in May.
Business Confidence:
ISM Manufacturing PMI: Contracted for the fourth consecutive month in July, falling to 46.8.
Philadelphia Fed Manufacturing Index: Soared to 13.9 in July, the highest level in three months.
Consumer Sentiment:
Michigan Consumer Sentiment: Revised higher to 66.4 in July, the lowest in eight months.
Conference Board Consumer Confidence Index: Fell to 66.4 in July, the lowest in eight months.
Trade:
Balance of Trade: The trade deficit widened to $75.1 billion in May, the largest since October 2022.
Exports: Fell 0.7% month-over-month in May.
Imports: Decreased 0.3% month-over-month in May.
Outlook:
The US economy is expected to continue expanding in the coming months, but at a slower pace than in the first half of 2024. Inflation is projected to moderate further, but the Fed's ability to achieve its 2% target without triggering a recession remains a key concern. The labour market is expected to cool further, with job growth slowing and the unemployment rate edging higher. The housing market is likely to remain subdued, with high prices and mortgage rates continuing to weigh on affordability.
Sources
U.S. Bureau of Economic Analysis (BEA)
U.S. Bureau of Labor Statistics (BLS)
Federal Reserve
Trading Economics
National Association of Home Builders (NAHB)
S&P Global
Institute for Supply Management (ISM)
Federal Reserve Bank of New York
Federal Reserve Bank of Atlanta
Federal Reserve Bank of Philadelphia
Federal Reserve Bank of Dallas
Federal Reserve Bank of Chicago
Conference Board
University of Michigan
Technometrica Market Intelligence/RealClearMarkets