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Good morning! Yesterday, we mentioned that Instacart’s IPO price was too low, but it seems the stock fell back to its offer price, experiencing an 11% decline from the previous day. Another recent debut, Arm, also experienced a fall. Could the IPO comeback be fizzling out? Feel free to email us at [email protected] and [email protected].
An appropriately humble Fed
Jay Powell’s dislike for the summary of economic projections (SEP) becomes more evident with each Fed press conference. The SEP, released every other Fed meeting, provides estimates from the 19 members of the Fed’s Open Market Committee regarding growth, employment, inflation, and interest rates for the current year and the next three years. It is simply a survey and does not form the basis for policy decisions. The confidence level of the members’ estimates is not recorded, but it is likely quite low. This means that the quantitative precision of the SEP, represented by the “dot plot” of rate policy expectations, is an illusion. Poor Powell is constantly bombarded with questions about it and responds with a hint of rising ennui, saying that they will monitor the data.
However, the SEP does provide valuable information, whether the chair likes it or not. When there are significant changes, it indicates that influential individuals who deeply analyze the economy have been forced to change their minds due to evolving events. In yesterday’s press conference, while the Fed decided to keep rates unchanged, the SEP underwent interesting and substantial changes. Here is a summary of the key points:
- Growth expectations for this year and next have notably increased since June.
- Expectations for unemployment have significantly decreased.
- Expectations for inflation have remained relatively unchanged.
These projections would have seemed almost insane six months ago. The idea of steady growth, extremely low unemployment, and inflation just half a percent away from the target would have been scoffed at by our former selves. And yet, here we are. The economy, or at least significant parts of it, has experienced a re-acceleration, as evidenced by the increase in consumer spending this summer. At the same time, core inflation has continued to trend downwards, albeit slowly, and unemployment has only marginally risen. Powell has always stated that achieving a soft landing is a narrow path, but it appears that we are indeed navigating it.
The policy aspect of the SEP is particularly intriguing. The committee’s collective expectation is for the policy rate to be 5.1% by the end of next year, only two quarter-point cuts below the current level. The market is not prepared for this, with futures implying an expectation of 4.7% in December 2024. Just a week ago, the expectation was 4.4%. As a result, stocks have slightly declined and short-term Treasury yields have risen. Reporters questioned Powell about the market’s unease, asking whether he was concerned that keeping nominal rates higher for longer, despite falling inflation, could lead to an unnecessary increase in real rates that would harm the economy.
While this is a valid question, we must remember the critical lesson of the past three years: we still do not understand much about inflation. Economists who correctly predicted the rise in inflation in 2021 and 2022, largely due to excess demand, failed to anticipate the rapid decline and economic strength of the past 12 months. On the other hand, economists who focused on the supply shock caused by the coronavirus pandemic were proven right about the severity of inflation but underestimated its initial magnitude. This suggests that we cannot confidently predict future developments. It is also wise to consider how higher rates may affect the economy, as the rapid increase in policy rates has impacted different sectors unevenly. Commercial real estate has been severely affected, the housing market has been frozen, and banks have faced challenges. However, large segments of the economy, including consumers, do not appear to have noticed these effects, despite low sentiment. As a result, we are uncertain whether we are at the beginning or the end of an economic cycle.
While today’s economic vitality may not last, Powell mentioned various forthcoming headwinds such as the autoworker strike, $90 oil, resumed student loan payments, potential government shutdown, and new highs in long yields. On the other hand, the US consumer has weathered worse conditions, and real wages are on the rise once again. The overall impact is uncertain. A significant deterioration in growth is plausible, but so is a short-lived fourth-quarter GDP “pothole,” as predicted by Goldman Sachs. Given the uncertainty, the committee is right to tentatively plan to keep rates higher for a longer period. The risk of causing a recession and the risk of allowing inflation to re-emerge are both real, but for now, the danger of the latter outcome seems more significant due to robust growth. However, if the data changes, the Fed can and will adjust its approach accordingly. (Armstrong & Wu)
One good read
No one tells a story of media intrigue quite like Michael Wolff.
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