Timing of Rate Cuts Remains Cloudy

Brent Schutte, CFA, is Chief Investment Officer of the Northwestern Mutual Wealth Management Company.

Investors pulled slightly back on their expectations for Fed rate cuts amid mixed economic data over the past week. However, Federal Reserve Chairman Jerome Powell's dovish comments kept the prediction at around three rate cuts for 2024 (although other Fed members have expressed varying opinions, leaning more toward a hawkish stance). The market is now pricing in a 50/50 chance of a rate cut in June.

We continue to believe the data indicates that we are late in an economic cycle—which is likely to give the Fed pause about cutting rates sooner rather than later. While wage growth has slowed to 4.1 percent year over year, the March figure rose .03 percent vs. an upwardly revised 0.2 percent in February. Wage growth continues to be stuck in the low 4 percent range. This is higher than the Fed's comfort level of 3 to 3.5 percent as we’ve noted in prior commentaries. Inflation has come down, but it looks like it’s stalled out, and some measures indicate it may be rising again. As we’ve mentioned in previous commentaries, the last leg of the inflation fight is often the toughest to overcome.

For us, it’s as simple as this: Will the Fed cut rates amid this backdrop? The longer rates remain elevated, the more they work their way into the economy and increase the likelihood of a recession.

Wall Street wrap

Manufacturing prices rise as new orders pick up amid sector growth: The latest data from the Institute for Supply Management (ISM) shows the manufacturing sector is now in growth territory for the first time in 16 months. The March reading is up 2.5 points, to 50.3 from February’s reading of 47.8. A reading of 50 or higher indicates expansion.

Readings for new orders came in at 51.4, up 2.2 points from February. Order backlogs continue to be in contraction territory, with the March reading holding steady at 46.3. Inventories remain low and are getting thinner with customer inventories checking in at 44.

As the manufacturing industry has begun to rebound, materials prices have reversed course and are not expanding, with the latest reading coming in at 55.8 percent, up from February’s reading of 52.5 percent. Notably, four of the six largest industries reported paying higher prices. In total, 11 of the 18 industries in the survey reported paying higher prices. This is the highest portion of industries reporting higher prices since July 2022, suggesting that inflation pressures may continue to be at risk of reigniting and broadening within the goods side of the economy.

The employment index rose 1.5 points in March from the prior month but remains in contraction at 47.4. In the latest release, Tim Fiore, chair of the ISM, highlighted that “panelists’ comments in March were again equally split between companies adding and reducing head counts. This approximately one-to-one ratio has been consistent since October 2023.” It’s noteworthy that 76 percent of the reductions in head count among manufacturers came from layoffs (up from 50 percent in February), with the hiring freezes and attrition accounting for the remainder.

Goods prices initially led the overall disinflationary process as price increases shifted to the services sector. With service sector inflation remaining stubbornly elevated, this report suggests we may be seeing some reinvigoration here, which could put additional upward pressure on inflation overall. It will be important to watch, as increased demand on this side of the economy could slow or even reverse the trend of falling goods inflation.

Growth in the services sector continues to ease: Meanwhile, ISM data for the services side of the economy showed that the pace of expansion slowed again in March, with a headline reading for the sector coming in at 51.4, down from 52.6 in February. While the pace of expansion softened, growth was widespread, with 12 of 18 industries recording growth. New orders eased, dropping to 54.4 from February’s reading of 56.1. That’s the lowest level since December of 2023. Along with slowing growth, demand for workers continues to remain in contractionary territory, with the employment index coming in at 48.5, up slightly from February’s reading of 48. The latest employment index reading marks the third time in the past four months that both ISM’s manufacturing and services employment surveys have been in contractionary territory. Reflecting the oddity of the post-COVID economic period, it’s unusual to see contraction like this without seeing actual job losses. Prior to the onset of COVID in early 2020, if you go back to the start of monthly ISM Services data in 1997, both services and manufacturing have been in contraction (below 50) in 44 months. In all but three of those months there were private-sector job losses.

On the inflation front, while the prices paid index in the survey remains in expansionary territory at 53.4, it’s down 5.2 from February’s reading of 58.6. and 10.6 from January’s reading of 64. Despite the continued drop, 13 of 18 industries report that they’re paying higher prices. This is in stark contrast to the strong job gains of the past four months.

To sum it up, while the manufacturing side of the economy is showing signs of coming out of the doldrums, the services side is slowing. Price pressures overall appear to be moderating given the drop in services, but goods prices are now increasing.

Nonfarm payrolls surge past Wall Street expectations: The Bureau of Labor Statistics’ (BLS) nonfarm payroll report showed the addition of 303,000 new positions in March—well above February’s downwardly revised reading of 270,000 and Wall Street forecasts of 214,000. March gains occurred in the health care, government and construction industries—with health care and government accounting for most of the gains. This is noteworthy because health care and government are less sensitive to economic conditions.

The BLS’s other jobs report, the household survey, showed the unemployment rate at 3.8 percent down from February’s 3.9 percent and the labor participation rate at 62.7 percent, an increase of 0.2 percent.

Meanwhile, wage data offered some hope on the inflation front. Average hourly earnings of private-sector production and nonsupervisory employees edged up 0.2 percent. Over the past 12 months, average hourly earnings have increased by 4.2 percent. While this is promising, it is still above the 3 to 3.5 percent range we believe is necessary for the Fed to reach its stated goal of 2 percent annual inflation. And a review of shorter-term measures shows that we remain stuck in the lower 4 percent area.

Job openings stay flat at 8.8 million: The BLS Job Openings and Labor Turnover Survey released last week showed the number of job openings came in at 8.8 million, little changed from January’s reading and down from a series high of 12.2 million in March of 2022. The so-called “quits” rate, which is viewed as a proxy for the level of confidence employees feel about the job market, came in at 2.2 percent for the fourth consecutive month, a measure not seen since September 2020.

Continuing jobless claims rise: Weekly initial jobless claims were 221,000, an increase of 9,000 from last week’s upwardly revised figure. The four-week rolling average of new jobless claims came in at 214,250, an increase of 2,750 from the previous week’s revised average. Continuing claims (those people remaining on unemployment benefits) stand at 1.791 million, a decrease of 19,000 from the previous week’s downwardly revised total. The four-week moving average for continuing claims declined to 1,799,750, down 750 from last week’s revised figure.

The week ahead

Tuesday: The National Federation of Independent Businesses Small Business Optimism Index readings for March will be out prior to the opening bell. Recent readings have indicated that price pressures and the state of the labor market continue to be chief concerns among small businesses, with many firms continuing to raise wages. We will watch for signs that suggest these challenges are easing.

Wednesday: Recent data from the BLS on its Consumer Price Index report has shown stalling progress in the disinflationary process. We will analyze this data to see if pockets of price pressures have begun to spread to other areas.

Wednesday will also offer a look at the minutes from the most recent meeting of the Federal Reserve Board. We’ll be looking for comments related to the potential timing of rate cuts as well as board members’ thoughts on the employment picture and wages.

Thursday: Initial and continuing jobless claims will be issued prior to the opening bell. Initial filings were down slightly last week, but the four-week rolling average of continuing claims rose. As always, we will continue to monitor this report for signs of changes in the employment picture.

The latest readings from the BLS on its Producer Price Index will offer a front-line view of changes in costs for buyers of finished goods. It can provide insights into the direction of input costs faced by businesses and can indicate how prices may move at the consumer level in the future.

Friday: The University of Michigan will release its preliminary report on April consumer sentiment and inflation expectations. We will watch to see if consumers are still feeling optimistic despite the likelihood of fewer rate cuts.

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