Debt ceiling: Common sense prevailed
Chief Economist Eugenio J. Alemán discusses current economic conditions.
Late on Thursday night, the U.S. Senate followed the House of Representatives in passing the deal brokered by the Biden administration and the Speaker of the House, Kevin McCarthy, and it will now go to the desk of the president to be signed, avoiding a potential global financial and economic crisis.
As we argued in our latest Thoughts on the Market (TOTM), the deal will have limited effects on economic activity over the next two years from reductions in government expenditures while helping to reduce economic and financial risks of default for, at least, two and a half years, which is not a small feat.
Furthermore, there are several mechanisms within the bill that will push Washington politicians to follow through on budget appropriations or risk further damage. However, these battles will not have the potentially disastrous consequences that a debt default would have had for the U.S. and the global economy.
In an ideal world, we would hope that we use this time wisely and put forward a long-term solution to our debt issues.
Markets and the next FOMC meeting
Markets expectations for the June FOMC (Federal Open Market Committee) meeting have been running wild. The day before the House of Representative passed the Fiscal Responsibility Act (FRA), a.k.a., the debt ceiling bill, market bets on the next Federal Reserve (Fed) move had gone to about 70% expecting a 25- basis point increase in the fed funds rate. The day after the House of Representatives passed the bill, almost 74% of the bets were for the Fed to stay put on interest rates during the FOMC meeting in June.
Today, and after the release of the nonfarm payroll for May, market bets are once again moving with the bets at 67.9% for a pause and 32.1% for a 25-basis point increase.1 Although today’s movement after the nonfarm payroll number seems rational, there was nothing in the FRA that could have pushed the Fed would move one way or the other.
True, as we argued in the TOTM, we believe that the agreement will be slightly disinflationary, but nothing that would have argued for a completely opposite view regarding expectations about the federal funds rate. Thus, we continue to expect the Fed to pause on its rate increase during the FOMC meeting scheduled for June 13-14 even after the strong May nonfarm payroll report as the rate of unemployment increased from 3.4% in April to 3.7% in June. However, we understand that the Fed’s decision will come down to the wire.
At that time, the Fed is also going to release the Summary of Economic Projections (SEP), which will help clarify its view regarding the economy, inflation, as well as interest rates expectations going forward.
Employment growth and inflation
We have continued to hear that one of the reasons for the Fed to keep increasing interest rates is that the labor market continues to be very strong. However, even if the labor market has remained strong, which it has, it hasn’t stopped inflation from slowing down since the peak in June of last year.
Although there has been research that has pointed to labor costs as one of the reasons for higher inflation, others have pointed out that labor costs are adding very little to current inflation or that there doesn’t seem to be a process indicating a wage-price spiral.2,3 Furthermore, a research piece from the Federal Reserve Bank of San Francisco from September of 2022 has also pointed out the changing components of wage inflation over time, showing that inflation expectations, in this case short-term inflation expectations, are now a much larger component of wage inflation than before the COVID-19 pandemic. 4 This is, perhaps, the most important reason why the Fed may consider continuing to increase interest rates. However, we still believe that the Fed will refrain from hiking during its coming June FOMC meeting as it continues to estimate the effects of last year’s increase in interest rates on economic activity.
Furthermore, as we argued above, wage pressures, while important, don’t seem to be the reason for high inflation or for inflation to continue to increase. However, it is, perhaps, one of the reasons why it has taken much longer for inflation to come back down.
Going forward, we are still expecting inflation to start moving lower at a faster pace as we expect shelter costs to have a lesser impact on inflation during the second half of the year. That is, we continue to expect the disinflationary process to continue unabated.
Economic and market conditions are subject to change.
Opinions are those of Investment Strategy and not necessarily those of Raymond James and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Last performance may not be indicative of future results.
Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.
Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.
Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.
The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.
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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.
The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.
The Conference Board Coincident Economic Index: An index published by the Conference Board that provides a broad-based measurement of current economic conditions.
The Conference Board lagging Economic Index: an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.
The U.S. Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the U.S. dollar gains "strength" when compared to other currencies.
The FHFA House Price Index (FHFA HPI®) is a comprehensive collection of public, freely available house price indexes that measure changes in single-family home values based on data from all 50 states and over 400 American cities that extend back to the mid-1970s.
Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).
ISM New Orders Index: ISM New Order Index shows the number of new orders from customers of manufacturing firms reported by survey respondents compared to the previous month. ISM Employment Index: The ISM Manufacturing Employment Index is a component of the Manufacturing Purchasing Managers Index and reflects employment changes from industrial companies.
ISM Inventories Index: The ISM manufacturing index is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories.
ISM Production Index: The ISM manufacturing index or PMI measures the change in production levels across the U.S. economy from month to month.
ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.
Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time.
Producer Price Index: A producer price index (PPI) is a price index that measures the average changes in prices received by domestic producers for their output.
Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.
The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.
The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index measures the change in the value of the U.S. residential housing market by tracking the purchase prices of single-family homes.
The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measures the value of residential real estate in 20 major U.S. metropolitan.
Source: FactSet, data as of 5/26/2023