Chief Economist, BB Asset Management, Brasil
US: activity, inflation and interest rate
Despite the FED (US Central Bank) having put in place the most intense interest rates in almost four decades, the American economy continues to show great resilience to rising interest rates, a dynamic quite different from that observed in other economies, especially the Euro Zone and the United Kingdom. In this sense, it is worth highlighting the performance of GDPNow calculated by the Atlanta FED for the 4th quarter of 2023 – GDPNow was developed based on a methodology similar to that used by the Bureau of Economic Analysis and seeks to provide a continuous estimate of real GDP growth with based on the economic data available for the quarter – which points to an annualized quarterly variation of 2.6% and an increase of 2.5% when comparing the years 2023 and 2022.
We can explain this dynamic by the introduction of programs such as the Inflation Reduction Act and CHIPS and Science Act, which together contributed another US$ 1.1 trillion in investments to the economy. Another possible path is the behavior of the Financial Conditions Index (FCI).
If during much of last year the measures for the three economies (USA, EZ and UK) went hand in hand, the data shows that from October/22 onwards financial conditions in the USA loosened, with approximately 1/3 of all tight made in the first ten months of 2022 being undone in just four months. Some vectors help in the explanation of the FCI's easing – the recovery of local stock markets, the improvement in corporate profit projections and the recovery in Treasury bond yields –, all motivated by the “certainty” that the FED would not just interrupt the rise interest rates but would also immediately begin cuts. Thus, at each meeting in which the FOMC increased federal funds, it committed to moving forward in the cycle and warned that it would not work with cuts, at the same time the interest rate curve started to incorporate the beginning of the trajectory of interest rate reductions in the very short term. In short, the rise in interest rates was not fully transmitted to financial conditions and the US economy was not severely impacted.
The performance of ISMs – indices that control the amount of production and services activity in the previous month; values above 50pts mean expansion and below contraction – it is a good example of this reality. The industry indicator, which had already progressed into contractionary territory in the last quarter of 2022, began to show modest signs of improvement in the last two readings. The index for services continues to remain in expansionary territory.
We are meeting the projection of a GDP slowdown in the US in 2024, with at least two quarters of negative results (1st quarter and 2nd quarter/24). To this end, it is worth highlighting that some factors, which have so far developed to loosen financial conditions, should begin to exert the opposite pressure, such as: the increase in the number of downward rating reviews; the assessment of bankruptcy filings and the percentage of banks tightening credit conditions for companies, which became positive in the second half of 2023; and the signals transmitted by econometric models – “Changes in Bank Lending Standards and the Macroeconomy” Federal Reserve Board, FEDS Working Paper, 2012 and “The Euro Area Bank Lending Survey Matters: Empirical Evidence for Credit and Output Growth” ECB Working Paper No 1160, 2010 –, of an already contracted drop in real GDP.
Furthermore, it is worth highlighting that: i) real interest rates were positive only recently, that is, they have not yet impacted the activity; ii) that according to Sahm's Rule, – a recession begins when the three-month moving average of the unemployment rate is at least half a percentage point above the lowest level in the last 12 months –, these states would already be in recession; iii) that the GDP of approximately half of the states showed a drop in the annualized quarterly variation; and iv) although the public securities curve is strongly tilted, an antecedent sign that was previously typical of recessions, a surprise persists with the activity indicators.
With regard to inflation, we continue to assess that the intensity of disinflation observed in recent months is not genuine, given that it is centered in fuels, due to the global drop in oil prices, and industrial goods, helped by the normalization in global production chains and distribution. In this sense, to assess current inflation becomes more important to observe core measures and services inflation, both more sensitive to monetary policy and economic activity.
With the job market quite tight, we understand that wages are the main driver of inflation. Therefore, as indicators show that developments are receding very modestly at the margin, we expect to see the second-round effects of the cores on headline inflation only in the coming months.
Therefore, despite the peaceful stance adopted by the current composition of the FOMC, with special emphasis on President Jerome Powell, we are maintaining the projection for the terminal interest rate in the range of 5.00% - 4.75% at the end of 2024.
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