Financial News for the Week of January 26th, 2024

• The U.S. economy ended 2023 on a solid note, with GDP rising 3.3% quarter-over-quarter (annualized) – smashing expectations for a more moderate gain of 2% in financial news.
• The consumer remained a key factor underpinning last quarter’s strength, with spending accelerating sharply through the holiday shopping season.
• Inflation continued to drift lower in December, with the 12-month change on core PCE – the Fed’s preferred inflation measure – slipping below 3%.

The latest data has shown the U.S. economy had all the markings of a soft landing as 2023 drew to a close in financial news. Economic growth held up better than expected, the labor market is coming back into better balance, and price pressures are quickly abating. Market pricing on the timing of the first Fed rate cut has seesawed between March and May in recent months, with March currently priced as a coin-toss. But with progress on the inflation front showing no signs of stalling, market sentiment remained in risk-on mode this week, with the S&P 500 edging up 1% for the week, reaching yet another all-time high. Shorter-term yields drifted a bit lower, leading to a further flattening in the yield curve. At the time of writing, the inversion of the 10Y-2Y spread had narrowed to just -20bps – well off the peak inversion of -110bps seen back in July.

The Bureau of Economic Analysis’ advance estimate of fourth quarter real GDP came in at 3.3%, a downshift from Q3’s blistering 4.9%, but well above the consensus forecast calling for a more moderate gain of 2% (see commentary). Economic resilience remained on full display, with the consumer, private investment, and government spending accounting for the lion’s share of last quarter’s gain (Chart 1). While the rearview mirror isn’t always the best guide to the road ahead, the solid end to last year provides a more favorable starting point heading into 2024.

This is especially true for the consumer. The monthly income and spend figures for December – released a day after the GDP report – showed consumer spending accelerated sharply through the holiday shopping season. This was happening even though the tailwinds from excess savings had slowed from the gale force gust felt at the beginning of the tightening cycle to just a gentle breeze by the end of last year. At the same time, 27 million student loan borrowers were faced with the harsh reality of having to restart regular loan repayments in October following the expiration of the three-year student loan moratorium. But neither of these factors appear to have phased the consumer, as a still sturdy labor market has continued to support meaningful gains in real income and help to sustain a healthy pace of consumer spending.

The puzzle has been on the inflation front. Despite the economy continuing to run well above its long-run potential through H2’2023, inflation has still made incredible progress. As of December, the 12-month rate of change on core PCE fell to 2.9%, while the annualized 3-and-6-month rates slipped to 1.5% and 1.9%, respectively (Chart 2). Falling goods prices and some cooling in non-housing services have both been the key contributors to the recent downward pressure on inflation.

From the Fed’s perspective, time (and the economic data) remain on their side. With the economy showing no signs of keeling over, and the labor market still relatively tight, policymakers can afford to be patient. Fed officials will want to see at least a few more ‘soft’ readings on inflation and a bit more easing in the labor market before pulling the trigger on rate cuts.

 

Thomas Feltmate, Director & Senior Economist | 416- 944-5730