By Kelvin Lee, Alonso Munoz
Are we experiencing a soft landing? Is the most anticipated recession in history about to commence? In a recent panel at the Titan Investors Global Business Connections in Miami, I queried a lineup of leading CIOs about the Goldilocks economic data and the overly optimistic market sentiment. Although the feedback was that of “cautious optimism,” the global outlook appeared scattered. For many of us who closely track data (without making forecasts…), it feels like the fate of the markets rests in the hands of Jerome Powell, the Chairman of the Federal Reserve. Our thoughts? It’s likely the Fed will begin cutting rates sooner rather than later, and they should. Despite the “strong” jobs and economic data, there are cracks in the economy that could widen, leading to the recession we have all been anticipating. – Alonso Munoz, Chief Investment Officer
On the back of unexpectedly robust economic data, the prevailing narrative for 2024 is “higher for longer rates.” Most economists seem to agree that the U.S. consumer is strong! People are still spending, which will keep inflation high, and as a result, the Fed won’t cut rates anytime soon. To be fair, the latest economic prints do lend some credence to this ideology. CPI is still notably above the Fed’s 2% target, retail sales are strong, and unemployment remains low. The Fed may have achieved a miracle: lowering inflation without destroying the U.S. economy.
However, we disagree with “higher for longer.” We anticipate rate cuts this year, and the basis for our conviction is simple: look under the “hood.”
First, we don’t believe the consumer is as healthy as economists suggest. As we discussed before, the strong consumer spending in December was fueled by BNPL (buy now pay later) and credit card spending. This, coupled with the holiday shopping season, drove shoppers to (over)extend their balance sheets. We’re just now seeing the effects in credit card earnings: Capital One’s (NYSE: COF) Q4 Earnings last Thursday showed more than $2.53 Billion in net charge-offs (delinquent debt). That’s more than a 77% jump from last year. Capital One also raised its provisions for future losses from $573M to $2.9B, indicating continued delinquency expectations. Simply put, people may not be able to pay their credit card bills.
(One other note on December’s strong retail sales number: Some economists reported that the surprisingly warm December in North America may have pushed sales higher. If their theory is right, then January’s cold front suggests spending will come in significantly lower (for January). Visa similarly reported Thursday that transaction volume is expected to come in weaker due to the colder weather).
Regarding unemployment, December’s low 3.7% print was, in our opinion, misleading. There were numerous indications of a weakening labor force in the data, but because the headline number was the same as November’s, the media and White House were quick to boast about a strong jobs market. In fact, more than 670 thousand people had actually left the labor force in December, the most since Covid. The unemployment rate stayed flat from a declining labor force, not a growing one. The number of employed persons and the participation rate also fell from November. It’s baffling how these results could be interpreted as a strong jobs market.
Overall, we expect the coming weeks to show a cooling labor market and a vast slowdown in spending. Already, the Fed’s preferred inflation gauge, PCE, came in cooler even with December’s robust spending. While Wednesday’s Fed decision is likely another hold, we estimate Friday’s unemployment number to come in near 4%. Although many may view the market’s pricing of 6 rate cuts this year as exaggerated, we believe the market consensus is fully justified. There’s plenty of weakness in the economic data releases; you just have to scroll past page 1 to find it!
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Kelvin Lee at email@example.com
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Alonso Munoz at firstname.lastname@example.org