Key Takeaways
- Inflation expectations over the next 12 months have convincingly improved, giving the Federal Reserve (Fed) reasons to pivot. We will likely notice improving inflation dynamics later this week.
- Risk appetite improved as investors considered bringing cash off the sidelines and into capital markets, pushing the markets to new all-time highs.
- Building permits, a leading indicator of future construction, accelerated in December as builders expect the housing market to improve as borrowing costs fall.
- The American Staffing Association’s staffing index hints at a softer-than-expected payroll print for the upcoming month.
To Cut or Not to Cut
As investors discuss the possibility of the Fed cutting rates in March and the extent to which the Fed is willing to acknowledge these cuts, here are a few significant charts to consider.
According to the University of Michigan survey, inflation expectations for the next 12 months dipped to 2.9%, the lowest since the end of 2020. As illustrated in the first chart below, the decline in inflation expectations is certainly good news for the Fed. Inflation expectations over the next 12 months have convincingly improved, giving the Fed the opportunity to cut rates as early as March but only if other data comes in weaker. Clearly, risk appetite improved as investors considered bringing cash off the sidelines and into capital markets.
Markets Recently Buoyed by Falling Inflation Expectations
Source: LPL Research, University of Michigan, 01/24/24
Residential Investment Supporting Growth
The consumer is not the only factor supporting economic growth. Construction activity is also providing a boost. Building permits, a leading indicator of future construction, accelerated in December as builders expect the housing market to improve as borrowing costs fall.
Falling mortgage rates should help demand for housing in the coming months. Despite the month-over-month decline in December starts, construction activity remains close to pre-pandemic levels. The low supply of existing homes on the market is nudging potential buyers to new construction. Despite Fed Chairman Jerome Powell’s warning, as the Fed embarked on its rate-hiking campaign of necessary pain, the economy seems to have managed to avoid significant pain, at least for now.
Construction Activity Should Improve This Year
Source: LPL Research, University of Michigan, 01/24/24
What Could Push the Fed to a Rate Cut
As illustrated above, the Fed has not inflicted much pain on the economy from its aggressive rate-hiking campaign to quell inflation. The mission is certainly not accomplished, which is why the Fed has not been too inclined to cut rates.
The sector that will likely determine the timing and magnitude of rate cuts is the job market. From the recent Institute of Supply Management (ISM) and National Federation of Independent Business (NFIB) survey data, businesses will likely slow the pace of hiring this year. So far, the pace of hiring has slowed but not alarmingly so. Wage growth has finally leveled up to where consumer prices are, which has helped consumer spending. However, investors should track the weekly staffing index from the American Staffing Association, which hints at a softer-than-expected payroll print for the upcoming month.
Job Growth Will Likely Slow Further
Source: LPL Research, American Staffing Association, Bureau of Labor Statistics, 01/24/24
Looking Ahead
Investors will likely focus on labor data to understand when and how the Fed might manage 2024. Currently, unemployment claims are low and layoff announcements are not causing concern, despite a few notable layoffs being reported in recent weeks. Since inflation trends are behaving nicely, markets will be closely watching how businesses plan to manage payrolls and any surprises in the job market could ignite some volatility.
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