Persistent strength has been the hallmark of the economy over the past 12 months. Despite the Federal Reserve’s actions to rein in inflation by keeping interest rates elevated (thus cooling the economy), overall levels of economic activity have continually surprised to the upside. More recently, we have begun to see signs that higher rates are acting as a restraining force on the economy. The Fed and most market participants will be hoping that while inflation returns to the longer-term target of 2%, the economy will avoid a more significant slowdown.
The employment picture showed signs of cooling in the second quarter but remains positive. In June, the economy added 206,000 jobs and averaged 177,000 jobs added each month of the second quarter. The unemployment rate in June came in at 4.1%, just up from 4.0% in May, which was the first time unemployment hit 4% since January 2022. Job openings have also decreased but remain above 8M, which is 1M greater than the pre-pandemic December 2019 level. These numbers indicate a slowdown is occurring in the labor market but at a pace that can be viewed as manageable.
Inflation, which saw a slight uptick in the first quarter, has cooled as well. Headline Consumer Price Index (CPI) increased 0.3% in April and was flat in May. While Core CPI (which strips out food and energy) increased 0.3% in April and 0.2% in May. Over the past 12 months, prices, as measured by CPI, have increased 3.3% and 3.4% for Core CPI. While these levels are above the Federal Reserve’s target for inflation, the overall trend indicates prices have stabilized and are moving down slowly. Inflation expectations remain incredibly important, and data points like Consumer Inflation Expectations (CIE) show us what consumers think will happen to prices in the future. The latest University of Michigan year-ahead inflation expectation also remains above the 2% Fed target at 3.3%. This survey measure represents the level of inflation consumers expect over the next 12 months and can factor into future Monetary Policy. This indicates an expectation that inflation will moderate and hints at continued economic growth that keeps prices from declining more quickly.
In line with the positive but cooling theme, the Atlanta Fed is projecting Q2 2024 GDP growth of +1.5%, following +1.4% in Q1 2024, a continuation of the decrease from the +3.3% in Q4 2023. Growth of 1.4-1.5%, while not overly strong, would be a very welcome sight this far into a Federal Reserve tightening cycle. The forecasted level of GDP growth indicates that we may finally be seeing the impact of interest rate hikes on the real economy, but the declines in activity appear to be sensible.
Several other economic indicators are providing signals of slowing but not to alarming levels. The cooling economic picture, persistent inflation concerns, and the election have all impacted consumer sentiment, which in May ticked below 70 for the first time in 2024 as measured by the University of Michigan Consumer Sentiment survey. We have also seen some recent weakness in Retail Sales data for both April and May, which aligns with our thesis that the economy is slowing at a reasonable pace.
Taken all together, we believe we are finally seeing the economic slowdown many market participants (including ourselves) had been anticipating to arrive sooner. While this may indicate a period where GDP growth is not as strong as the past few quarters or an uptick in unemployment, we do not anticipate a sudden or drastic stalling of the economy. The pace of activity coming out of COVID was unlikely to continue unimpeded, especially with the Federal Reserve attempting to slow the pace of inflation. We remain optimistic that this environment is one in which our focus on high-quality equities and fixed-income positions can provide solid risk-adjusted returns.
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