Tag: Stock price indexes

The FOMC Follows the Expected Course in Its Latest Meeting

Chair Jerome Powell at a meeting of the Federal Open Market Committee (photo from federalreserve.gov)

At the beginning of the year, there was an expectation among some economists and policymakers that the Fed’s policy-making Federal Open Market Committee (FOMC) would begin cutting its target range for the federal funds rate at the meeting that ended today (May 1). The Fed appeared to be bringing the U.S. economy in for a soft landing—inflation returning to the Fed’s 2 percent target without a recession occurring. 

During the first quarter of 2024, production and employment have been expanding more rapidly than had been expected and inflation has been higher than expected. As a result, the nearly universal expectation prior to this meeting was that the FOMC would leave its target for the federal funds rate unchanged. Some economists and investment analysts have begun discussing the possiblity that the committee might not cut its target at all during 2024. The view that interest rates will be higher for longer than had been expected at the beginning of the year has contributed to increases in long-term interest rates, including the interest rates on the 10-year Treasury Note and on residential mortgage loans.

The statement that the FOMC issued after the meeting confirmed the consensus view:

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated. In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective.”

In his press conference after the meeting, Fed Chair Jerome Powell emphasized that the FOMC was unlikely to cut its target for the federal funds rate until data indicated that the inflation rate had resumed falling towards the Fed’s 2 percent target. At one point in the press conference Powell noted that although it was taking longer than expected for the inflation rate to decline he still expected that the pace of economic actitivity was likely to slow sufficiently to allow the decline to take place. He indicated that—contrary to what some economists and investment analysts had suggested—it was unlikely that the FOMC would raise its target for the federal funds rate at a future meeting. He noted that the possibility of raising the target was not discussed at this meeting.

Was there any news in the FOMC statement or in Powell’s remarks at the press conference? One way to judge whether the outcome of an FOMC meeting is consistent with the expectations of investors in financial markets prior to the meeting is to look at movements in stock prices during the time between the release of the FOMC statement at 2 pm and the conclusion of Powell’s press conference at about 3:15 pm. The following figure from the Wall Street Journal, shows movements in the three most widely followed stock indexes—the Dow Jones Industrial Average, the S&P 500, and the Nasdaq composite. (We discuss movements in stock market indexes in Macroeconomics and Essentials of Economics, Chapter 6, Section 6.2 and in Economics, Chapter 8, Section 8.2.)

If either the FOMC statement or the Powell’s remarks during his press conference had raised the possibility that the committee was considering raising its target for the federal funds rate, stock prices would likely have declined. The decline would reflect investors’ concern that higher interest rates would slow the economy, reducing future corporate profits. If, on the other hand, the statement and Powell’s remarks indicated that the committee would likely cut its target for the federal funds rate relatively soon, stock prices would likely have risen. The figure shows that stock prices began to rise after the 2 pm release of the FOMC statement. Prices rose further as Powell seemed to rule out an increase in the target at a future meeting and expressed confidence that inflation would resume declining toward the 2 percent target. But, as often happens in the market, this sentiment reversed towards the end of Powell’s press conference and two of the three stock indexes ended up lower at the close of trading at 4 pm. Presumably, investors decided that on reflection there was no news in the statement or press conference that would change the consensus on when the FOMC might begin lowering its target for the federal funds rate.

The next signficant release of macroeconomic data will come on Friday when the Bureau of Labor Statistics issues its employment report for April.

Does the Latest GDP Report Indicate the U.S. Economy Is Entering a Period of Stagflation?

Arthur Burns was Fed chair during the stagflation of the 1970s. (Photo from the Wall Street Journal)

This morning, Thursday April 25, the Bureau of Economic Analysis (BEA) released its advance estimate of real GDP growth during the first quarter of 2024. The two most striking points in the report are, first, that real GDP increased in the first quarter at an annual rate of only 1.6 percent—well below the 2.5 percent increase expected in a survey of economists and the 2.7 percent increase indicated by the Federal Reserve Bank of Atlanta’s GDPNow forecast. As the following figure shows, the growth rate of real GDP has declined in each of the last two quarters from the very strong growth rate of 4.9 percent during the third quarter of 2023.  

The second striking point in the report was an unexpected increase in inflation, as measured using the personal consumption expenditures (PCE) price index. As the following figure shows, PCE inflation (the red line), measured as a compound annual rate of change, increased from 1.8 percent in the fourth quarter of 2023 to 3.4 percent in the first quarter of 2024. Core PCE inflation (the blue line), which excludes food and energy prices, increased from 2.0 percent in the fourth quarter of 2023 to 3.7 percent in the first quarter of 2024. These data indicate that inflation in the first quarter of 2024 was running well above the Federal Reserve’s 2.0 percent target.

A combination of weak economic growth and above-target inflation poses a policy dilemma for the Fed. As we discuss in Macroeconomics, Chapter 13, Section 13.3 (Economics, Chapter 23, Section 23.3), the combination of slow growth and inflation is called stagflation. During the 1970s, when the U.S. economy suffered from stagflation, Fed Chair Arthur Burns (whose photo appears at the beginning of this post) was heavily criticized by members of Congress for his inability to deal with the problem. Stagflation poses a dilemma for the Fed because using an expansionary monetary policy to deal with slow economic growth may cause the inflation rate to rise. Using a contractionary monetary policy to deal with high inflation can cause growth to slow further, possibly pushing the economy into a recession.

Is Fed Chair Jerome Powell in as difficult a situation as Arthur Burns was in the 1970s? Not yet, at least. First, Burns faced a period of recession—declining real GDP and rising unemployment—whereas currently, although economic growth seems to be slowing, real GDP is still rising and the unemployment rate is still below 4 percent. In addition, the inflation rate in these data are below 4 percent, far less than the 10 percent inflation rates during the 1970s.

Second, it’s always hazardous to draw conclusions on the basis of a single quarter’s data. The BEA’s real GDP estimates are revised several times, so that the value for the first quarter of 2024 may well be revised significantly higher (or lower) in coming months.

Third, the slow rate of growth of real GDP in the first quarter is accounted for largely by a surge in imports—which are subtracted from GDP—and a sharp decline in inventory investment. Key components of aggregate demand remained strong: Consumption expenditures increased at annual rate of 2.5 per cent and business investment increased at an annual rate of 3.2 percent. Residential investment was particularly strong, growing at an annual rate 0f 13.2 percent—despite the effects of rising mortgage interest rates. One way to strip out the effects of net exports, inventory investment, and government purchases—which can also be volatile—is to look at final sales to domestic purchasers, which includes only spending by U.S. households and firms on domestic production. As the following figure shows, real final sales to domestic purchasers declined only modertately from 3.3 percent in the fourth quarter of 2023 to 3.1 percent in the first quarter of 2024.

Looking at these details of the GDP report indicate that growth may have slowed less during the first quarter than the growth rate of real GDP seems to indicate. Investors on Wall Street may have come to this same conclusion. As shown by this figure from the Wall Street Journal, shows that stock prices fell sharply when trading opened at 9:30 am, but by 2 pm has recovered some of their losses as investors considered further the implications of the GDP report. (As we discuss in Macroeconomics, Chapter 6, Section 6.2 and Economics, Chapter 8, Section 8.2, movements in stock price indexes can provide some insight into investors’ expectations of future movements in corporate profits, which, in turn, depend in part on future movements in economic growth.)

Finally, we may get more insight into the rate of inflation tomorrow morning when the BEA releases its report on “Personal Income and Outlays,” which will include data on PCE inflation during March. The monthly PCE data provide more current information than do the quarterly data in the GDP report.

In short, today’s report wasn’t good news, but may not have been as bad as it appeared at first glance. We are far from being able to conclude that the U.S. economy is entering into a period of stagflation.