According to The Federal Reserve (Fed), when implementing Monetary Policy, they have a ’dual mandate’ of low, stable inflation and maximum employment. In simple terms, this means that by setting rates and intervening in financial markets, their goal is to guide the economy to a state in which people who want to work either have a job or are likely to find one quickly, and the price level is stable. In the current state of the economy, it may be reasonable to say that half of the mandate (employment) is being met, but the other half (inflation) has room to improve.
The employment picture has been very strong post-pandemic. In March, the economy added 303,000 jobs and averaged over 275,000 jobs added each month of the first quarter. The unemployment rate in March also came in at 3.8%, marking 26 consecutive months of below 4% unemployment. Furthermore, there are currently approximately 8.75M job openings in the U.S., indicating a sustained appetite for hiring more workers. This strong employment picture remains in place despite the fastest interest rate hiking cycle in over 40 years.
Inflation, however, remains more difficult to control. While inflation has decreased significantly from the peak of approximately 9% in July of 2022 to 3.5% in March, as measured by the Consumer Price Index, this remains above the Fed target of 2%. Elevated inflation may have had a psychological effect on consumers that the Fed takes seriously. Addressing fears of resurgent inflation is important as expectations of future inflation guide consumer behavior and can lead people to spend before prices go up, which exacerbates current inflation. Data points like Consumer Inflation Expectations (CIE) become more important in this environment. The latest University of Michigan year-ahead inflation expectation was 2.9%, well above the 2% target. This survey measure represents the level of inflation consumers expect over the next 12 months and can factor into future Monetary Policy.
The economy has continued to grow at a fairly reasonable pace. After growing at an annualized rate of 3.4% in Q4 2023, the Atlanta Fed is projecting Q1 2024 GDP growth of 2.4%. Overall economic growth appears to be slowing but is still significantly more robust than had been expected at this point, given the rapid increase in interest rates meant to slow inflation by slowing the economy. The forecasted level of GDP growth remains above the current estimated long-term trend level of GDP (1.8%), signaling that the economy is stronger than would be expected at current levels. Continued strength in retail sales data over the last six months also shows the strength of the consumer. In fact, consumer sentiment just hit a 3-year high, and manufacturing (ISM) expanded for the first time since 2022. As economic activity has remained robust, the Fed may be more patient in maintaining its restrictive policy stance.
Resilient economic activity, a healthy jobs market, and declining but sticky inflation may mean the Federal Reserve doesn’t have to make significant changes to its interest rate policies this year, as discussed in John’s commentary. Last quarter, we suggested the market was overly optimistic about the pace of interest rate declines given inflation and growth. It now looks like markets may be coming around to this view, as well. In this environment, many companies have demonstrated an ability to sustain profitability and increase profit margins. We continue to believe that high-quality assets will provide the best opportunity to provide upside returns and mitigate downside volatility.