Is the U.S. Economy Reaccelerating?
11th February 2024 | ⏰ 00:04:28
Is the U.S. Economy Reaccelerating?
TLDR: The US economy may be set to reaccelerate, with manufacturing and non-manufacturing sectors showing signs of improvement. This could challenge the market's expectation of Fed rate cuts in 2024, potentially leading to a repricing of risk assets.
Navigating Market Uncertainties: The Economic Tightrope and Implications for Risk Assets
Global markets are constantly evolving, influenced by a myriad of factors that can impact investor sentiment and asset prices. In this edition of The Man from Macro, we delve into the complexities of the current economic landscape, exploring key data points and their implications for markets. We examine the potential for a US economic reacceleration, the challenges faced by policymakers, and the subsequent impact on risk assets.
Data Points: ISM Surveys and Senior Loan Officer Survey
The Institute for Supply Management (ISM) surveys provide valuable insights into the health of the US economy. The manufacturing index, a measure of activity in the manufacturing sector, has been hovering below 50, indicating contraction territory. However, it has shown signs of recovery, reaching its highest levels since late 2022. If it crosses back into expansion territory, it would mark one of the longest periods below 50 without an official recession.
Meanwhile, the ISM non-manufacturing index, which gauges activity in the services sector, stands well above contraction territory at 53.4. Notably, the prices paid component has witnessed a significant rebound, reaching one of its highest levels in over a decade, excluding the post-COVID surge. Given that the services sector accounts for approximately 80% of the US economy, this surge in prices paid implies continued support for inflation, complicating policymakers' efforts to achieve the 2% target.
The US Senior Loan Officer Survey offers further insights into the lending landscape. The number of large and medium-sized firms reporting tighter standards has started to decline, while demand for loans has been increasing. Historically, such tight lending conditions have often preceded an official recession. However, if conditions are indeed improving, it suggests the economy may be poised for renewed growth.
Economic Reacceleration: Implications and Challenges
An expanding economy is generally considered a positive development. However, in the current context, it could potentially disrupt market expectations and impact risk assets. The market narrative has oscillated between two primary camps: those anticipating an organic economic slowdown and recession, and those expecting the economy to remain resilient, necessitating hawkish actions from either the Federal Reserve or the bond market to curb inflation.
The recent data has provided some support for the latter camp. The implied rate derived from the FED funds curve still suggests approximately 100 basis points of cuts by the end of the year. However, if both the manufacturing and non-manufacturing ISM indices signal expansion while the US equity market remains near all-time highs and unemployment hovers around 4%, policymakers may find less incentive to initiate rate cuts.
Navigating the Tightrope: Market Vulnerability and Policymaker Dilemmas
The unusual economic dynamics observed in recent years, characterized by a piecemeal and stop-start slowdown, have resulted in an optically tight labor market despite potential weaknesses in the jobs market. This situation has allowed inflation to remain elevated, yet not to the extent of triggering a policy panic. However, maintaining this delicate balance is challenging.
If the recent market rally was largely driven by repricing rates to a lower level, a reversal of these expectations could expose equities to vulnerability in 2024. Conversely, if markets desire rate cuts, they may need to incentivize policymakers through lower equity valuations.
Conclusion: Economic Reacceleration as a Double-Edged Sword
A reacceleration of the US economy could present a double-edged sword for risk assets. While it signals economic strength, it could also challenge market expectations of looser monetary policy. This could lead to a repricing of risk assets and potential volatility.
The current economic environment demands careful navigation, as policymakers and market participants alike attempt to decipher the complex interplay between growth, inflation, and policy decisions. Investors should remain vigilant, monitoring economic data and market developments to make informed investment decisions in the face of evolving economic dynamics.
Q1. What is the current state of the US economy, and what are the implications for markets?
A1. Recent data, including the ISM manufacturing and non-manufacturing indices, suggest that the US economy may be poised for a reacceleration. The manufacturing index is rebounding off its lows and could soon cross back into expansion territory, while the non-manufacturing index remains well above contraction territory. However, the prices paid element of the non-manufacturing index has seen a significant bounce, indicating that services inflation remains a concern.
Q2. How might policy makers react to a reacceleration of the economy?
A2. A reacceleration of the economy could complicate the Federal Reserve's efforts to bring inflation down to its 2% target. If the economy continues to grow and unemployment remains low, the Fed may be less inclined to cut interest rates, as this could further fuel inflation. This could lead to a tightening of financial conditions and a potential headwind for risk assets.
Q3. What are the implications for markets if the economy reaccelerates?
A3. A reacceleration of the economy could have mixed implications for markets. On the one hand, it could lead to higher corporate profits and potentially higher stock prices. On the other hand, it could also lead to higher interest rates, which could make it more expensive for companies to borrow money and invest. Additionally, a reacceleration of the economy could lead to higher inflation, which could erode the value of returns on investments.
Q4. What is the market narrative regarding the US economy, and how has the recent data impacted it?
A4. The market narrative regarding the US economy has been bouncing between two base camps. One camp expects the economy to roll over into an organic slowdown and recession, while the other expects the economy to remain resilient, requiring hawkish activity from the Fed or the bond market to cap inflation. The recent data has given a boost to the camp that expects the economy to remain resilient, as it suggests that the economy may be reaccelerating.
Q5. What could incentivize policy makers to start cutting rates?
A5. If the market wants the Fed to cut rates, it needs to incentivize them. This could require a lower equity market, as this would signal that the economy is weakening and that the Fed needs to take action to support it. Additionally, a rise in unemployment or a significant decline in inflation could also incentivize the Fed to cut rates.