The debate over just how much cutting the Fed will do this year comes down to one factor: How well the economy does. Sure, the Fed is mandated to care about inflation and ensure full employment. But whether or not it can achieve those targets this year (or, even, in the next couple of months) is a function of how the economy performs.
The vast majority of economists now think the US has most likely avoided a recession. That means the Fed is most likely not going to make the emergency fast rate cuts that it does in the midst of a market meltdown. The debate is whether it will cut around 6 times over the next 10 months, mirroring the aggressive rise in rates. Or it will go through with its threat of cutting only three times (or less, according to several FOMC members).
Just how fast the economy is growing will be pivotal as to which of those paths (or something in between) the Fed will take. If the economy keeps growing at a relatively healthy clip (not unusual for an election year), then so will inflation and the jobs market will remain tight. That means the Fed will have to keep rates up to prevent a resurgence in inflation.
But, if the economy slows substantially, and trends closer to stagnation (that is, a “soft landing”), then inflation would also fall. That wouldn’t be so much of a problem for the Fed, but slow economic growth would also translate into a weak jobs market. Thus, it might be forced to cut rates in order to meet its second mandate of full employment. The market appears to be betting on this scenario for now.
To give us some insight into which option is more likely, there is a trove of economic data coming out between today and tomorrow. The most important, and will certainly claim all the headlines, is the release of preliminary Q4 GDP. And, after last quarter’s outsized performance, a natural pullback is expected. But just how much it slows down could be the key to the market’s reaction.
The consensus is that the US grew at an annualized rate of 2.0% over the last trimester. This is actually below what the Fed’s “nowcast” tool is forecasting, at 2.4%. Often, the preliminary figure matches the Fed’s number more closely, with the revision later moving to match the consensus of the economists’ views. That means there could be an initial beat in US growth, taking the market a bit by surprise.
Depending on how much the number beats or misses, traders are likely to be most interested in why? Last quarter’s blow-out figure was thanks to strong growth in personal spending. But that’s expected to not be the case this time around. If personal spending, and businesses capital expenditure plans, are both lower than expected, it could be a sign that the economy is slowing down. That could leave the dollar substantially weaker as investors renew their bets on more rate cuts. Outperformance would vindicate the Fed’s more hawkish stance, and likely support the dollar.
The other important data point is Durable Goods, published at the same time. December business spending on long-term investments is expected to come to a screeching halt, rising only 0.1%, well below the 5.4% reported previously. Then on Friday is the release of personal income and spending, which is expected to largely stay in line with the figures from the prior month. That could help reassure markets if there is a bit of a surprise in the GDP number.
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- Source: https://www.orbex.com/blog/en/2024/01/us-q4-gdp-how-much-of-a-slowdown
