Today is a big data day: the May inflation report this morning and a Fed update this afternoon. Investors have been anticipating the opportunity to overreact to both all month!
I write that tongue-in-cheek, but there's an element of truth to it. When the broad economic trends are clear, each incremental data point tends to carry diminished importance. But when we reach a point in the economic cycle where the dominant trends become unclear, investors tend to overemphasize each new data point. That can cause markets to swing back and forth on new data that may not really be especially significant.
U.S. growth slowing?
In the June Private Client update (the video of which will be available to SMI Premium-level members here next week), I discussed three themes we're keeping an eye on. You'll have to come back for the other two, but here's what I wrote earlier this week about the evolving U.S. economic growth picture:
U.S. economic growth may be cooling slightly after starting the year stronger than expected. Every data point indicating cooling gets investors riled up. But context is important here, as the U.S. economy stood virtually alone last year by defying recession expectations throughout 2023.
More context: Hedgeye Research recently reported five different U.S. economic statistics (including aggregate wages, consumption spending, retail sales, and GDP) all between +5.8% and +6.2% nominal annual growth. It’s hard to be overly concerned about slowing growth with that kind of data.
True to form, after investors got worked up over slowing U.S. growth data in early June and markets briefly wobbled, last Friday’s jobs report came in much stronger than expected and alleviated those concerns for now.
Given that, here's how to connect the dots of today's Inflation/Fed data releases. The Fed wants to cut interest rates — they've been telegraphing that since December. Thus far, they've been stymied by U.S. growth being stronger than expected. Remember that nearly everyone was calling for a recession at the end of 2023 and markets had priced in between six and seven rate cuts for 2024 as a result.
The thought was that slowing growth (or an outright recession) would bring inflation down to the Fed's stated 2% annual target. But with the economy staying so strong, that didn't happen, and inflation actually started to inflect higher again. That made investors nervous, as the one thing that has spelled big trouble over the past few years has been rising interest rates, which tend to follow along with the general direction of inflation.
That was largely the state of affairs through the first 3-4 months of this year: stronger economic growth and stickier (perhaps even rising) inflation.
Over the past several weeks though, the data has gotten a lot more mixed, with plenty to support the idea that the U.S. economy may be slowing. Not slipping into recession, just cooling a bit. That's why this morning's inflation report caused such a big market reaction — it indicated inflation was cooler in May than was expected and reversed the trend of recent months that showed inflation might be picking up steam again.
May's cooler inflation rate adds additional support to the idea that the economy may be slowing. Lower inflation and a slowing economy have been the prerequisites for the Fed to start cutting interest rates. Which sets the table for the Fed's announcement this afternoon regarding their current rate-cut expectations.
Keeping Fed expectations in context
Six months ago, the Fed thought the economy was slowing dramatically, inflation was headed to 2%, and they'd be cutting rates throughout 2024. None of that ended up transpiring. That should give anyone pause in overreacting to whether the Fed sees one rate cut vs. two over the duration of the year.
However, slowing inflation does add incremental support to the idea of future rate cuts. Investors are hoping this portends an extension of the "goldilocks" environment they've experienced so far in 2024: an economy that's not too hot, not too cold, but just right. Frankly, whether or not the Fed cuts interest rates by 0.25%, or even 0.50%, this year, that seems like the path of least resistance.
That's really the key takeaway today. Regardless of these short-term wiggles in the data or Fed-speak, the U.S. economy is chugging along at a reasonable clip, inflation is still higher than the Fed (or the American people) are comfortable with, and investors are pretty comfortable with this mix as evidenced by continued market gains and new all-time highs for the S&P 500 and Nasdaq indexes.
Given SMI's strong trend-following bias, those are trends to keep riding until something substantial enough to clearly disrupt them comes along.
