Inflation is coming down and the economy not suffering enough to cut rates.

The U.S. economy exhibits robust growth with a Q4 2023 GDP increase of 3.2%. Inflation, while decreasing, follows a non-linear path. The housing market awaits lower mortgage rates and increased supply. Manufacturing faces challenges, contracting for the 16th consecutive month. Consumer confidence dipped in February, potentially influencing future rate cuts. Bad news for the economy is good for a market that is awaiting cuts.

The pace of economic activity is slowing, yet growth remains robust. This data gives the Fed margin to keep higher interest rates. The economy shows a steady and manageable economic expansion.

In the fourth quarter of 2023 reported a 3.2% increase in GDP, slightly lower than the initial estimate of 3.3% and below the 3.3% consensus estimate. The growth primarily resulted from increased consumer spending, exports, and state and local government spending, while imports, subtracted from GDP, also rose. Notable contributors to consumer spending included services such as healthcare and food services, as well as goods like pharmaceutical products and recreational goods. The second estimate revealed higher-than-expected growth in Personal Consumption, contributing 2.0% to GDP, up from the original estimate of 1.91%. Fixed investment and government contributions also increased, but a significant drop in the change in private inventories offset these improvements.

We are seeing a strong economy in the United States with inflation still high and well above target. We expect higher interest rates for longer than the market expects. Our interest rate cut expectations by the Fed point towards June.

Inflation rose in line with expectations. On an annual basis, inflation dropped, pushing expectations of rate cuts to H2 of this year. We are seeing more and more evidence that inflation is falling but not linearly.

The PCE demonstrates improvement, registering a 2.4% standing. Conversely, the US core PCE deflator sees a 0.4% MoM increase. Monthly comparisons are witnessing a re-acceleration, with the annualized rate at 3 months holding at 1.8%, and at 6 months, it stands at 2.5%, both signalling an upward trajectory. The core PCE benefits from the most substantial YoY goods deflation in this cycle, even though durable goods exhibit MoM increases. The supercore PCE experiences a notable 0.60% rise, marking the most robust increase since December 2021. Financial services contribute more than 10% to the supercore's monthly increase. Ex-shelter services remain a concern for February, with a 3.45% YoY increase. Personal income sees a 1% rise, while consumer spending, previously robust for months, records a 0.1% decline. Worker compensation increases by 0.4% MoM, alongside jumps in dividend income and a 2.6% rise in transfer payments, reflecting the 3.2% cost of living adjustment for social security recipients (surge tax payments + inflation = no growth real household disposable income). Despite potential monthly fluctuations, the disparity between "rising income" and declining spending raises the possibility that inflation might decrease.

While the overall trend in inflation is decreasing, it is not following a linear path and monthly rebounds are expected. Our perspective remains fixed on the first-rate cuts in the H2, with an expectation of just two cuts throughout the year.

The sector's reactivation depends on a drop in mortgage rates and an increase in supply, with potential implications for inflation. The housing sector is super sensitive to small changes in mortgage rates in the current outlook.

Building permits dropped a marginal 0.3% (vs. -1.5% Dec). New home sales demonstrated remarkable strength, registering a 1.5% increase in January (vs. 7.2% Dec). With an annual growth of 1.8%, the market observed both builders and buyers taking advantage of lower mortgage rates early in the year. Despite slightly falling below expectations, the sales of newly built homes continued to rise, indicating heightened housing demand and sustained builder confidence as we enter this year's home shopping season (late spring and summer). Pending home sales in the US descending below 2008 levels, with a concerning 6.9% YoY decline in January. This contributes to a five-week consecutive drop in mortgage demand, highlighting persistent difficulties in the housing market.

In the housing market, single-family home prices increased by 0.1% in December 2023, with an annual rise of 6.6%. The S&P CoreLogic Case-Shiller index reported a significant 6.1% YoY increase in housing prices across 20 US cities, marking the most substantial surge since November 2022. Notably, no major city reported a YoY drop in house prices for the first time since November 2022.

Looking forward, housing prices are expected to continue rising due to limited supply, emphasizing the need for a drop in mortgage rates and an increase in supply to reactivate the market and manage inflationary pressures.

Manufacturing sector remains in contraction territory. Orders for manufactured goods fell more than expected in January amid a sharp drop in bookings for commercial aircraft, while the picture for business investment in equipment was mixed.

Manufacturing in the U.S. contracted in February with the Manufacturing PMI at 47.8, marking the 16th consecutive month of contraction. The New Orders Index contracted for the 18th time in 20 months at 49.2. The Production Index declined to 48.4, indicating contraction for 11 of the last 15 months. Employment contracted for the fifth consecutive month at 45.9. Supplier Deliveries slowed at 50.1, and Inventories contracted at 45.3. Prices increased for the second consecutive month at 52.5.

In January, durable goods orders witnessed a significant downturn, plummeting by 6.1% (vs. -0.1% Dec), representing the most substantial decline since April 2020. The prevailing uncertain economic conditions have prompted companies to curtail their investments in equipment, evident in the sharp 7.3% decrease in new orders (excluding defence). Particularly striking was the drastic drop of nearly 60% in bookings for commercial aircraft, marking the most significant decrease since June 2020. Despite these challenges, a positive note emerges as non-defence capital goods orders, excluding aircraft, showed a modest uptick of 0.1% (vs. -0.6% Dec).

The Chicago PMI, the February data reveals a decline to 44 (vs. 46 Jan), marking the third consecutive monthly decrease. Key metrics include a faster rise in prices paid, a slower decline in new orders, a slower decrease in inventories, and a faster decline in production, while employment remains in contraction.

The manufacturing sector continues to grapple with challenges, showing limited signs of recovery after the production decline in 2023 and a substantial 525 bp increase in interest rates. Our perspective posits that a modest rebound in the sector may only materialize when interest rates begin to decrease. Current data suggest that the Federal Reserve is not urging to implement such rate cuts.

After recovering between November and January, consumer confidence fell in February. Meanwhile, consumer recession expectations rose.

Consumer confidence dipped to 106.7 (vs. 110.9 Jan), reflecting a decline in the current situation to 147.2 (vs. 154.9 in Jan). This downturn is attributed to consumers expressing concerns about both business conditions and the employment situation, with a pessimistic outlook. Furthermore, the expectations index decreased to 79.8 (vs. 81.5 Jan), driven by renewed pessimism regarding future business conditions and labour market prospects. Notably, it's important to acknowledge that the data has been consistently revised downward for the fourth consecutive month. January witnessed one of the biggest bearish reversals since February 2022. In terms of recession, consumers' perceived likelihood of a recession in the next 12 months inched up in February.

According to the University of Michigan, consumer sentiment remained relatively stable, experiencing a minor two-point decline from January but maintaining the positive trend of the past three months. Expected business conditions were notably higher than in the previous autumn, with short and long-term expectations up. Despite perceiving few changes in the economy since the start of the year, consumers expressed confidence that inflation would continue on a favourable trajectory. Year-ahead inflation inched up to 3.0% in February, and long-term inflation expectations remained at 2.9% for the third consecutive month, slightly elevated compared to the pre-pandemic range.

In a general context, it stands as a favourable indicator for the stock market, (in a no-recession scenario) and bears for the bond market as well. The Fed could consider rate cuts due to a decline in consumer confidence. From our perspective, with a prudent approach due to inflation and a strong labour market, we projected a cut rate in the latter half of the year and an expectation of no more than two cuts in total.