Second Quarter 2024 Commentary
The topic of interest rate cuts continues to dominate the financial markets. Investors remain focused on when the Federal Reserve will lower rates, while keeping a close eye on corporate earnings and valuations. Economists are analyzing inflation and labor market data to determine their impact on the probability and timing of rate cuts. Speeches by Fed members and minutes of recent Fed meetings have received greater scrutiny as investors search for clarity about the central bank’s next steps.
This commentary discusses investors’ focus on the Federal Reserve, recaps second quarter performance and looks ahead to the remainder of 2024.
Global Central Banks are Starting to Cut Rates
While the Federal Reserve waits for more confirmation that U.S. inflation will return to its 2% target, the trend among global central banks has shifted decisively away from tightening. Central banks cut interest rates early in the pandemic to protect against unknown risks associated with shutting down the economy.
When the economy reopened and inflation soared to multi-decade highs, they reversed course and raised interest rates with the goal of easing inflation. Interest rates were left at these high levels while waiting for inflation to slow, as evidenced in the rate plateau from 2022 into 2023.
Entering the third quarter, central banks are starting to cut interest rates as inflation slows around the world. More than 10 central banks have cut rates, including Canada, Switzerland, and the European Central Bank. The monetary policy environment is shifting from rate hikes to rate cuts, and investors expect this trend to continue in the coming quarters as more banks cut interest rates. However, this easing cycle is likely to be more staggered than previous cycles, with central banks cutting interest rates at varying speeds based on their unique inflation and economic growth conditions.
Analyzing Economic Trends & Surprises From 2Q24
A theme from the past few years has been the U.S. economy’s strength compared to the rest of the world. U.S. homeowners locked in low mortgage rates during the pandemic, which has protected them from the immediate impact of higher rates. However, mortgage rates reset more frequently in some countries outside the U.S., with those borrowers feeling the impact of higher rates sooner.
The Citigroup Economic Surprise Index, which compares economic data releases against Wall Street’s estimates is something we follow. A positive reading indicates economic data is stronger than anticipated (positive surprises), while a negative reading signals more negative surprises. In March 2022, the index turned negative as the Federal Reserve started to raise interest rates. The increase in negative surprises signaled a slowdown in response to early rate hikes. During the past two years, the index stayed mostly positive as the economy remained resilient, with most economic data points surpassing expectations.
During the second quarter, there was an increase in the number of negative economic surprises as the U.S. economy underperformed expectations. Job growth slowed in April, and the unemployment rate rose to 4% in May. Notably, the job growth figures for April and May havesubsequently been revised down by a combined 111,000 jobs. Retail sales declined in April, raising concerns about the financial health of U.S. consumer and potential stress for lower-income households.
If consumers cut back too much, employers may respond by lowering head count. May manufacturing survey data signaled a slowdown, and the U.S. Census Bureau reported the economy grew more slowly in the first quarter than initially estimated.
Investors are debating what the recent negative surprises indicate. However, there isn’t a clear relationship between negative surprises and the rate of economic growth. Rather, the index is more of a reflection of how the economy is performing relative to investor (or more specifically, Wall Street analysts) expectations.
The more appropriate question may be whether the U.S. economy is returning to its pre-pandemic trend after growing at an above-average rate since the pandemic’s end. If so, investors may need to adjust their expectations to match the economy’s new equilibrium
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