¶ Introduction
Hello, and welcome to Notes on the Week Ahead, a J.P. Morgan Asset Management podcast that provides insights on the markets and the economy to help you stay informed in the week ahead. Hello, this is David Kelly. I'm Chief Strategist here at J.P. Morgan Asset Management. Today is June 10th, 2024.
Every three months, the 19 members of the Federal Reserve's Federal Open Market Committee, or FOMC for short, aided, no doubt, by an army of econometric minions, work up new forecasts for key economic variables and their assessment of appropriate monetary policy. In recent days, as they've huddled in their offices engaged in this task, they've had much to be thankful for.
The economic rollercoaster triggered by the pandemic and the policy response, which manifested itself in wild swings in output unemployment and inflation, has subsided. Moreover, the very narrow road by which they thought inflation could be subdued without triggering recession turned out to be not so narrow after all. The U.S. economy has maintained solid economic growth and a very tight labor market even as inflation has fallen towards their 2% objective.
However, the outlook is, to say the least, foggy. Due political risks abound even as an approaching U.S. Election carries the potential for significant policy changes with with regard to taxes, immigration, and trade. Moreover, government data are becoming less reliable, with wide gaps emerging between estimates of output and income, and numbers produced by the two main employment surveys.
On such a foggy road, while members of the FOMC will, as usual, provide their best guesses as to the direction of the economy, they'll be reluctant to change their current stance of monetary policy.
¶ Market Outlook and Economic Data
The week ahead will be a busy one for markets, with fresh data on inflation and continuing questions about the sustainability of both the economic soft landing and the still very concentrated rally in US stocks. However, the highlight of the week will be communications from the Fed on Wednesday. They're very unlikely to change either short-term interest rates or their current pace of quantitative tightening.
However, they will release a new Summary of Economic Projections, or SEP, and a new dot plot, showing their expectations for key economic variables and short-term interest rates. They will also have the opportunity to add nuance to these forecasts through the FOMC statement and Chairman Powell's press conference.
¶ Fed’s Economic Forecasts
So what changes are they likely to make to their forecasts? And how could these changes impact markets? Well, the SEP includes forecasts for only four economic variables, year-over-year real GDP growth, headline PC inflation, core PC inflation, and the unemployment rate. These forecasts are provided for the fourth quarters of 2024, 2025, and 2026. In their March projections, the FOMC forecast real GDP growth for 2024 of 2.1%.
Three months later, this forecast appears to be on track. Consumer spending on healthcare, travel, and entertainment continues to grow strongly. However, spending on non-durable goods, such as food and clothing, was lower in April than it was in December, suggesting that lower- and middle-income households are having to retrench. In addition, investment spending on structures, and equipment appears to be slowing, presumably in a lagged reaction to higher interest rates.
Notwithstanding a payroll jobs surge in May, we expect year-over-year real GDP growth to slide from 2.9% in the first quarter to 2.0% by the fourth, essentially in line with the Fed's numbers. Thereafter, the Fed projected real GDP growth of 2.0% in both 2025 and 2026, with growth falling to 1.8% in the long run. This continues to seem plausible, possible, as both job growth and GDP growth are currently getting a temporary boost for immigration that's likely to fade in the years ahead.
In March, the SEP showed the unemployment rate rising from 3.9% in February to an average of 4.0% by the fourth quarter. Last Friday's jobs report showed an unemployment rate of 4.0% in May, or 3.96%, taken out to two decimals. It's quite possible the Fed will boost its unemployment rate forecast to 4.1% or even 4.2% for the fourth quarter to reflect the lagged impact of slower economic growth.
Alternatively, they could boost their unemployment rate estimates on the theory that the latest entrants drawn into the labor market may be more prone to bouts of unemployment than those who have been employed throughout the last few years. Either way, it's worth noting that the Fed's long-run forecast of the unemployment rate is 4.1%. Like economic growth, the Fed's forecasts show the labour market very close to where they want and expect it to be. Which brings us to inflation.
In March, FOMC participants projected headline PCE deflation inflation of 2.4% by the fourth quarter and 2.6% for core inflation. We now expect, based on data through April, that these numbers will be a little stronger than those projections, at 2.5% of the headline level and 2.8% of the core. One reason for this slightly hotter-than-expected inflation is stubbornly strong shelter inflation.
After declining by two percentage points from 8.2% year-over-year in March of last year to 6.2% in December, it only fell a further 0.7% by April of this year to 5.5%. We do expect it to keep easing based on newly negotiated rents. However, if this decline mirrors the slower pace of recent months, it will limit the potential for shelter to erode measured inflation.
Second reason is auto insurance. Many, including myself, assume that with auto insurance rates up by 20.3% year-over-year in December, rates would have to grow more slowly in 2024. So far, this hasn't transpired, with auto insurance up a astonishing 22.6% year-over-year in April. These are, to some extent, special and temporary factors. However, Fed communications will likely express dissatisfaction with the slow pace at which inflation is traveling this last leg on its journey back to 2%.
We expect the summary of economic projections to add one-tenth of a percent to participants' forecasts for both headline and core inflation in both 2024 and 2025, with the economy only attaining the nirvana of 2% inflation by the end of 2026.
¶ Implications of Revised Economic View
Given this slightly revised view of the economy, what messages will the Fed likely send about the future part of monetary policy. There are likely to be only minor changes in the FOM statement or in Jay Powell's opening statement at his press conference. The text could allude to recent data showing a slightly higher inflation rate and a slightly higher unemployment rate, factors that would be offsetting from the perspective of financial markets.
However, the dot plot will very likely show an adjustment in expectations for Fed policy. In March, of the 19 FOMC participants, 10 forecast three or more cuts in 2024, while nine forecast two or fewer. It's very likely that the new dot plot will show a majority expecting two or one, with markets potentially reacting favorably to the first of these two possible outcomes and unfavorably to the second.
¶ Fed’s Monetary Policy Future
On balance, the Fed's communications may sound slightly more hawkish than in recent meetings. However, they are also likely to stress the uncertainty of the present moment. They will have noticed, as economists generally have noticed, that the two major employment services are saying radically different things about the U.S. economy. According to the payroll survey, the economy gained a booming 2.8 million jobs over the past year.
However, according to the household survey, it only added a paltry 376,000 workers over the same 12 months. And this is not the only glaring discrepancy. Nominal GDP, adding up the components of output in the economy, grew by 5.4% in the year it ended in the first quarter. However, adding up all the income received in the economy and making appropriate accounting adjustments, there's only a 4.3% gain on the other side of the ledger.
The statistical discrepancy, the amount by which the income and output accounts of our national income statements disagree, has now swelled to $621 billion, or more than 2% of GDP.
¶ Navigating the Foggy Economic Road
The economy appears to be on a good road, but it is a foggy one for both policymakers and investors. The confusion in the data only makes it more likely that the Fed will resist calls either to cut rates soon or to tighten further. It's also an argument for investors to be well diversified, despite a continued strong bull market in large-cap U.S. stocks. That's it for this week. Please tune in again next week. And if you have any
questions in the meantime, please reach out to your J.P. Morgan representative. Advice or make an independent evaluation before investing. The value of investments and the income from them may fluctuate, including loss of capital. Past performance and yield are not indicative of current or future results. Forecasts and estimates may or may not come to pass. J.P. Morgan Asset Management is the asset management business of J.P. Morgan Chase & Company and its affiliates worldwide.