| Uri Greenfeld, the chief strategist of Psagot Investment House
“Forever” is what goes through economists, in particular economists in the capital market, when they are sure that some economic event that should occur is delayed. How do you say? You don’t time the market, the market times you.
The data of the last two weeks which clearly showed that the condition of the American consumer is still very good raised again question marks regarding the global disinflation process and the level required to bring it back towards the target. Although there is no doubt that the slowness with which the current phase of the economic cycle is progressing can throw off any sane person,
We will repeat here again the same thesis that we have been presenting for quite a few months now: according to both economic theory and the empirical data we received from an examination of all business cycles in the US since 1960, it takes about a year and a half for interest rate increases to affect the labor market, and then between six months to another year until the effect On reaching the peak.
The Fed knows exactly the same theories and the same data so that although the slowness of the process probably drives the members of the monetary committee out of their minds, they are also aware that there is no way to speed up the process without causing too much damage to the economy.
| January data may be misleading. It is better to wait for the February data to draw conclusions
The month of January is a problematic month in everything related to macroeconomic data and the implementation of the goals we set for the new year such as sticking to the gym. In quite a few data that are published during the month there are one-time effects such as updating data backwards, various linkages to inflation (we forgot this was relevant in the 15th year before the corona) and weather effects (also relevant for February).
In the three figures whose impact on the markets in the last two weeks was the greatest – the report, the consumer price index, and there were such one-time effects to one degree or another. The employment report was of course affected by the backward update of the 2022 data, but it was also probably greatly affected by the weather and the deduction of seasonality When the non-seasonally adjusted data showed a loss of 2.5 million jobs in January, 358 thousand more than the average January in the last decade.
The inflation figures were also probably affected by the weather and they were also updated backwards so that according to the old figures the core inflation should have been lower. Finally, the retail sales figures were clearly affected by January’s unusual weather, but also by a one-time 8.7% update in the National Insurance payments as a result of inflation and salary adjustment (affecting approximately 70 million consumers).
Bottom line, there is no doubt that backward updates and seasonality deductions are part of the game and the Fed ends up taking the data as it is.
Therefore, the increase in expectations for the Fed interest rate implicit in the contracts is certainly reasonable (100% probability of increases of 25 basis points in March and May and 55% of another increase in June). However, we will not be very surprised if the February data surprise us downwards and the probabilities will be updated accordingly.
| The recession is delayed but eventually it will come
The data published in the last two weeks were indeed better than expected, but they do not change the general picture, the Fed’s interest rate hikes will do the job and lead the American economy into recession. However, the data convinces us more and more that the recession will be delayed this time longer than usual and that it will be relatively shallow.
The main reason for this is the huge amount of savings accumulated by households during the Corona period. For those who forgot or repressed, for almost two years we all sat at home and spent much less money than usual. On the other hand, the income of the households was not harmed thanks to the government incentives when in the US these incentives were on steroids both on the household side and on the business side.
Therefore, although there is no doubt that the real income of households has been eroded in the last year more severely than in the crisis of 2008, it is also worth remembering that it soared in an unprecedented way during the corona virus when, in addition, expenses dropped significantly. According to the various estimates, the excess savings of American households during the Corona period reached about 2 trillion dollars.
Consumers in the US use this savings to reduce the damage to real income and according to the same estimates, the extent of using the surplus savings so far is only about a quarter to a third. In other words, consumers have more surpluses that they can use later in the year, so the damage so far is much less noticeable than in cycles predecessors.
So it is true, the consumer is not the be-all and end-all and already today you can already see signs of a slowdown in the real estate market data, in industrial production or in the index of the leading indices. However, in the American economy the weight of the consumer is of course high and accordingly, it is likely that the economic recession will manifest itself Only towards the middle of the year and not in the first quarter as we estimated earlier.
What does it mean for the Fed? Will the interest rate rise to a higher level than embodied in the market? we don’t think The Fed is aware that the process is expected to be long and repeats time and time again the mantra of “high interest rates over time”. In addition, it is worth remembering that the drop in inflation that comes from the supply side and is not related to interest rates or the economic cycle also affects inflation expectations, thus doing the job for the Fed and raising the real interest rate.
Therefore, the talk of an interest rate of 6% still seems to us far-fetched and it is likely that the terminal interest rate will indeed be around 5.25%. On the other hand, the likelihood that interest rates will fall this year is lower than the markets are pricing in as the Fed will want to be sure that the labor market is no longer an inflationary threat before it considers starting the process of interest rate cuts. Since the labor market is expected to start responding only in the second half of the year, it is quite possible that the interest rate will only start to decrease during 2024.
The writer is the chief strategist of Psagot Investment House and has no personal interest in the subject of the review. This review is not intended to be a substitute for investment marketing that takes into account the data and the special needs of each person.