US Economy: Weekly Commentary – December 19, 2023
US Market Views Synopsis
The Federal Reserve kept interest rates unchanged and indicated that it is thinking about cuts. We do not expect cuts until the second half of the year.

The combination of a fragile economy and the downward trend in inflation gave reason for the Fed to keep interest rates unchanged. The manufacturing sector is struggling, and inflation rebounded a bit in November, mainly due to housing prices. Whilst there was an uptick in employment and retail sales, typical of this time of year – it is not expected to persist. Despite talks about cuts next year, on balance l, we don't expect the Fed to cut rates until the second half of the year since it won't risk an uptick in inflation.

Interest rates decision
The Fed maintained rates at current levels. Next year is an election year, so the Fed does not want to have problems putting the economy into a recession. The economy is weakening, inflation is falling, and unemployment is projected to rise to 4.1 per cent in 2024. Additionally, we will see declines in aggregate demand.

The Federal Reserve has sounded more dovish whilst keeping interest rates unchanged at 5.25-5.5 per cent for the third consecutive meeting. They acknowledge that the economy is slowing, that unemployment will rise to 4.1 per cent in 2024 and that inflationary pressures, although still high, are declining. The have forecast a further rate cut in their projections to 75 basis points in 2024 but this is still less than what markets were pricing beforehand (it was discounting 100% bp). Federal Reserve officials forecast inflation at 2.4 per cent in 2024 and will return to the 2 per cent target in 2026. On balance the dovish tone and control over inflation has fuelled expectations of more rate cuts in 2024 than expected.

Looking ahead to next year we will see how aggregate demand will decline with a contraction in the private sector, which we do not believe will be very large. The US economy has everything lined up for a soft landing.

The bond market collapsed after Powell's announcement to maintain rates with indications that there were already internal discussions about lowering rates. The 10-year bond reached 4 per cent (effectively providing what is in effect a rate cut through lower cost of capital), stock markets have risen and are expected to continue doing so for the remainder of the year and gold rose thanks to the drop in real interest. Even if the recession happens, gold and bonds are the biggest winners.

The Fed's decision to maintain rates is what we already expected. Furthermore, we believe that rates in the United States will be the last to drop, although analysts are pointing to a drop in May.
Inflation commentary
Inflation picked up somewhat in November, however the general trend is downward. Nothing that affects future Fed decisions.

In November, the Consumer Price Index (CPI) rose by 0.1% on a seasonally adjusted basis, following a stagnant October. This aligns with market predictions. Over the past year, inflation increased by 3.1%, in line with expectations.

Core inflation, excluding volatile food and energy prices, grew by 0.3% in November and by 4% compared to a year ago. Energy prices decreased by 2.3% MoM, contributing to a check on inflation; gasoline fell by 6%, and fuel oil dropped by 2.7%. Meanwhile, food prices rose by 0.2%, driven by a 0.4% increase in food away from home. Annually, food prices rose by 2.9%, while energy prices decreased by 5.4%.

Shelter prices, a significant part of the CPI, increased by 0.4% in the month and by 6.5% over 12 months. However, the yearly rate has been gradually declining since its peak in early 2023. However, it needs to decrease more in the coming months and it looks like will have more hikes. This uptick together with a 1.6% increase in used cars and trucks prices drove the month-on-month inflation increase.
Despite the rise in inflation, the general trend continues to be downward. Furthermore, the last section is usually the most difficult to reduce. In the short term, we see further increases in house prices due to tight supply and the potential increase in demand as mortgages decline. Market expectations are already leaning towards rate cuts before the second half of the year, we do not believe that the Fed will get that far ahead, it does not want inflation to shoot up again and we do not expect cuts until the second half.
Consumer behaviour
The labour market remains resilient and the Christmas season is here, both events pushed retail sales up by 0.1 per cent in November. However, it cannot be sustainable in early 2024.

November saw a 0.1% uptick in retail sales, a rebound from the revised 0.2% drop in October, a pattern common during the Christmas season. Even, the labour market remains strong, with initial jobless claims and continuing claims data better than expected. In Christmas and summer, both retail sales and jobs usually rise. However, our forecast anticipates a pessimistic turn for both retail sales and the job market in early 2024. We expect a surge in unemployment and a decline in retail sales due to reduced consumer spending influenced by high-interest rates, impacting overall aggregate demand.
Manufacturing sector commentary
Services grew and created jobs, while the manufacturing sector is contracting and employment declines continue to be seen. The big issue for the US economy is the manufacturing sector.

The US composite PMI increased to 51 from November's 50.7, indicating a mild uptick in business activity. However, there's a big split between services and manufacturing. Services showcased faster growth, while manufacturers faced a slight decline, primarily due to a faster decrease in new orders.

Job growth, while modest overall, saw its quicker pace since September. The employment gains were driven by service providers, with the sector noting the fastest rise in headcounts since June. In contrast, manufacturing companies continued shedding jobs for the third consecutive month.

Rising material and fuel prices, coupled with increased wage bills, added pressure on costs in December. Input price inflation accelerated to its sharpest pace since September, although it stayed in line with historical trends. While slower than the average of the last three years, inflation regained momentum at year-end for both manufacturing and service sectors.

The NY manufacturing index plummeted to -14.5 in December, marking its lowest reading in four months and signalling a decline in business activity in NY. New orders dwindled for the third straight month, as did shipments. The employment index dropped to -8.4, its lowest level in months. There's an expectation of improvements in business conditions, orders, and shipments in the future, but the labour market might face worsening conditions.

Industrial production saw a modest recovery, increasing by 0.2% in November, falling short of the market's 0.3% expectation. However, on an annual basis, production decreased by 0.4%. The month-on-month rise was driven by increased vehicle production, attributed to the return of workers who had been on strike.

In general, our outlook is that the manufacturing sector is struggling like in Europe, and we expect more worsening. However, the economy does not suffer enough to cut rates in the first half of the year, as some people expect.
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