Victory at 2 percent-ish

Resurgent inflation risk and persistent inflation After a series of hot inflation readings to start off the year, investors are worried that price pressures are coming back. Gasoline futures are up, likely to hit gas stations in the next six weeks. The NFIB’s measure of companies planning to raise prices remains stubbornly high. Growth is moderating a bit, some measures of employment are cooling—and yet inflation is up too. A record number of apartments is under construction, which, as the year unfolds, should help one of the stickiest inputs to CPI, housing. The other sticky component, the cost of labor, has come down but remains persistent thanks to both wage growth and low unemployment. Unemployment has been below 4% for more than two years now, something not seen since the end of the 1960s. If tightness in the labor market is structural, reaching the Fed’s 2% target may require below-trend growth. Unless the Fed wants to relax that target a bit.

Fed pivot, Fed schmivot. On New Year’s Day, the market wanted six cuts, then five, then four, and now three. The Fed is keeping us all in suspense. So what? As Strategas notes, we are now at 238 days that the Fed has been “on hold.” That’s the second-longest pause ever. Historically, the market likes a long pause: up 13% on average for a pause of 100 days or more vs. a net loss when the pause is less than 100 days. Wolfe sees a growing expectation that the Fed will condone a hot U.S. economy this year. The market has responded by piling into risk assets, sending momentum as a stock-picking factor to the 94th percentile and driving SPAC stocks (!) to a new high. Encouragingly, market leadership may be moving away from the Magnificent 7 and towards cyclicals such as industrials and financials. Only 60% of tech stocks are above their 50-day moving average, the lowest level this year. $11 billion has flowed out of energy ETFs since inflation’s 2022 peak, a washout prompting Strategas to wonder if the uptick in oil spells an opportunity here. Fundstrat points out that the market doesn’t show signs of frothy excess right now. This is a profit-driven rally. The Magnificent 7 (or 5) have seen their gains because of strong earnings. Much of the rest of the market has delivered profit margin increases of late and not been noticed. If rewarded for such, the market may keep advancing.

The immaculate disinflation and the inflation truth The Fed thinks we can have steady growth and 2% inflation, mainly due to labor force growth (immigration) and supply-chain improvements, and perhaps the central bank is right. Immigration looks to contribute 0.3% to GDP growth this year, and low-cost Chinese goods are helping to keep inflation in check. Container freight rates have been falling, and that’s helping too. Immaculate disinflation!? The CPI is up 20% since the pandemic began four years ago. Goods and services have gone up the same amount, but the rise in goods prices was faster and ended sooner. Wages are up 21.2%, too, so consumers should be OK. But Gallup’s recent economic confidence index finds 63% of U.S. adults claiming inflation has caused financial hardship for their family. The CPI food and energy indexes are up 25% and 33% respectively, with insurance premiums for homes, auto and health care up even more. Even stable costs after 40-year-high inflation will put you in a mood. At his press conference, Chair Powell maintained that a couple of bad inflation readings were not cause for alarm. And FOMC participants think the pace of Fed balance-sheet runoff can be slowed. The Fed now toggles between two and three cuts this year. And we all depend on the data. This week I delivered my AI presentation in tony Palm Beach. The group of highly accomplished women from diverse fields were impeccably dressed. I couldn’t afford to go shopping with any of them, though my Manolo Blahniks held their own! They were far more interested in this AI revolution (exciting advancements across all industries, but also cultural, legal, privacy, employment and other concerns) than the next Fed meeting. Truth!

Positives 

• Credit the weather Housing starts jumped in February by 10.7%, defying expectations, although absolute levels were still low. Building permits, which are less weather-sensitive, rose 1.9%, missing consensus by a hair. Sales of existing homes leaped 9.5% as the supply of homes for sale rose 5.9% year-over-year. Indeed, builder confidence improved in March to the highest level since July, while the six-month outlook rose to the highest level since June.
• A step in the right direction The Leading Economic Indicators edged up +0.1% in February, breaking a long run of soft readings. A rise in the manufacturing work week together with the surge in stock prices offset the ISM, yield curve and consumer expectations.  
• Slowing, but still growing … S&P Global’s U.S. Composite PMI continued to reflect growth in March, albeit a bit more slowly than in February. While manufacturing rose from the prior month, services fell. Both remained above 50, indicating expansion, though these levels are soft for an economic expansion. The Philadelphia Fed’s manufacturing survey dipped a bit in March but remained positive, beating expectations.  

Negatives

• … improving but still contractionary The eurozone’s March flash composite PMI improved +0.7% on the month to a still-contractionary 49.9% vs. 49.7% expectations. PMIs for Germany and France were weaker than countries at the periphery, who benefited from tourism and stimulus. Economic engine Germany is still the eurozone’s weakest link. 
• In China, it’s worse Home sales have been contracting for three years, with residential square footage sold dropping 30% year-over-year. The population there has decreased by 2.9 million over the past two years. There were just nine million births last year, the lowest in records dating back to 1950, and the working age population has been falling since 2017.
• Everyone’s worried about commercial real estate Indeed, some $544 billion in CRE debt matures in 2024; about half of that is on the books of banks. CRE losses currently stand at just 0.31% but that figure is rising. Given looming rate cuts, restructurings (often for a year or so) might kick the can down the road to perhaps brighter days.

What Else

• If no June cut, then is the Fed political? In the 13 presidential election years since 1974, the Fed has changed rates more often than not (eight times vs. five). Still, if it wishes to minimize controversy, it might want to avoid starting in July (in between the political conventions) or September (when the campaign is in fullest swing). If so, and assuming the economy does not force the Fed’s hand, June, November and December are the most likely months to cut.
• Make politics boring again President Biden got a bump from the State of the Union, but his approval rating remains below 40%. Strategas thinks he’ll need to get above 45% to win. Trump is now ahead in all the swing states—both in a head-to-head matchup and in a five-person race.
• What?! The world’s wine growers are facing an excess capacity problem and have taken to ripping up their vineyards. Since at least 1995 consumption has lagged supply, but recently the imbalance has grown more acute, particularly with regard to red wine. The causes include Chinese tariffs, a trend toward lighter white and rose wines, and an abstemious Gen Z.