More Evidence of a Slowing Economy – When Will the Fed React?

‍

The incoming data says that the economy is cooling; shhh! – don’t tell the equity market. The major indexes rose in the 1.3%-2.0% range for the last week in May and were up significantly for the month with Nasdaq leading the charge advancing 9.6% (see table). This market action appears to be more related to the tariff file (on again off again) rather than to underlying economic conditions.¹

‍

All the Magnificent 7 were up in the 2%-3% range for the week. So, a very good week for equity investors. And it was a great month for all except Apple (AAPL).  The average gain for the week was nearly +2.5%; and +13.5% for the month. Still, on average, on a year-to-date basis, the Magnificent 7 remain in negative territory (-4.2%). ¹

‍

Slowing Economy

The soft data (based on surveys) have been signaling that the economy, specifically economic growth, is softening. Not quite a Recession, but could turn into one if that softening turns into contracting numbers. ^{2 3}

• A recent NY Federal Reserve Survey found that one in eight respondents said they would be unable to meet a minimum debt payment in the next three months.² 
• In a recent Wall Street Journal edition (Thursday, May 22^nd) there were two articles of relevance to this topic:
  
  • Walmart Cuts Jobs in Restructuring Move: Walmart execs said they would eliminate -1,500 jobs, and, while that isn’t a lot for a company the size of Walmart, it also implies that they aren’t, on net, hiring.² 
  • Americans Scale Back Vacation Plans: This means more road trips and fewer airline flights and implies a slowing in the leisure/hospitality sector.² 

• The most recent JOLTS (Job Openings and Labor Turnover Survey) indicates a rapidly falling rate of new hires from private businesses and much less job hopping than has recently been the case. We’ve now seen a couple of upticks in the U3 Unemployment Rate, now at 4.2%. According to the latest Federal Reserve meeting minutes, the Federal Open Market Committee sees this rate going to 4.5% by year’s end.^{3 4} Our view is more pessimistic as we see the Unemployment Rate approaching 5% by then.⁴ 

• The soft data soon turns into hard data. For example, Q1 GDP growth showed up with a negative sign (-0.2%). We suspect that Q2 will also show up negative.⁴  Another example is the negative numbers in the most recent housing data:
  
  • Single family starts were down -14.0% in March and then in April, they fell a further -2.1%;⁵
  • Pending Home Sales were down -6.3% in April, adding to the nearly -1% March slowdown. To quantify the magnitude of this issue, the Pending Home Sales Index, at 71.3, is now lower than at the worst level of the Great Recession in November ’08 when the index’s nadir hit 80.2⁵;

• The monthly data series for median home prices almost never falls except in Recessions. But the Case-Shiller Home Price Index showed a negative sign (-0.3%) in March for the first time since January 2023, i.e. 28 months ago. (Is this a Recession sign?)⁵

• Auto and credit card delinquencies have risen to levels seen in the ’08 Recession and finished apartment unit lease up time has elongated to what we observed in the last Recession.⁶

• Orders for Durable Goods in April fell -6.3% from March levels.⁷
• Retail sales have been flat to negative (down slightly in 3 of the last 4 months).⁷
• Manufacturing has been flat to negative for the last 18 months.⁷
• In an uncertain world, consumers tend to tighten their purse strings. The chart shows a record level of uncertainty, so it isn’t any wonder that the economy has begun to slow.⁴ 

Will the Fed Adjust?

It is generally accepted in economic circles that when the Fed alters monetary policy it takes several months to percolate through to the general economy.³  Given the weakening soft data, some of which has already shown up in the hard date (i.e., housing, and GDP growth), the Fed should be actively moving monetary policy toward ease.³  

To repeat: Because of the lag between Fed actions and the impact of those policy changes on the economy, the Fed should be acting now, when the survey (soft) data is telling it that the hard data will soon show up weaker.³ 

But not this FOMC or its Chair. According to Chair Powell, the FOMC is waiting for the weakness in the soft data to show up in the hard data! A good example is the rate of inflation. For some strange reason, unbeknownst to the public, the Fed (and therefore the media) choose to concentrate on the year/year CPI inflation rate. In April, that year/year CPI was +2.3% - getting close to the Fed’s 2% target.³  And that appears to be where the analysis ends. Looking further, however, reveals that the three-month annualized CPI was 1.6%, below their 2% target. Now, a key CPI component is rents (35% weighting in the CPI index). But the rents used in the calculation are lagged nearly a year. If current rents were used, the three-month annualized rate computes to just +0.7%, Inflation is withering! In our view, we could actually end up with a bout of deflation over the next year or so.³ 

Based on this analysis, the Fed appears to be behind the curve, hung up on lagging indicators. They should be lowering aggressively now. But market odds for a rate cut in June are about 5%, and only 27% for the July meeting. Markets think that we will have to wait for the September 16-17 meeting to see the next cut (75% odds).¹ From the analysis above, the Fed appears to be behind the curve!

‍

Final Thoughts

Financial markets appear to be reacting to the policy uncertainty surrounding Trump’s tariffs (on again, off again…), and ignoring the incoming data which imply a slowdown in the economy.^{2 3}  There is a significant amount of soft (anecdotal) data regarding a weakening economy, all the way from Regional Federal Reserve Bank surveys to analysis in the Wall Street Journal.²  

The last few JOLTS have shown a slowing jobs market. And the U3 Unemployment Rate has had a couple of upticks. It appears that the job market is softening (rapidly) and that the Unemployment Rate (U3) will be heading higher.^{3 4}

We’ve already seen Q1 GDP growth with a negative sign. Chances are that will also be the case in Q2. Retail sales have been flat and so has manufacturing output. This could mean Recession.⁷ The housing market is certainly in a downturn.⁵ If Q2 GDP growth is negative, that satisfies the two-quarter rule (i.e., a Recession occurs when GDP growth is negative for two quarters in a row).⁴ Will this time be different? We hope so, but won’t be counting on it.

Will the Fed adjust in a timely fashion? We don’t know for sure, but based on past actions and recent pronouncements, odds are they will wait too long once again. We hope we are wrong!³

‍