A potential slowdown in the economy and inflation are apparent in the latest economic news and signs of further monetary restraint in March.
The Week That Was
Friday’s report on income and spending provided the first hints of a slowdown in both the overall economy and in inflation. We are encouraged that this is occurring right on schedule.
However, one month’s data is hardly definitive. This week’s news should provide a more complete picture of any slowdown. Up to now, most economic news has pointed to a strong economy.
Things to Come
Today’s business surveys on manufacturing are likely to provide some new insights. The only guide we have is S&P’s advance business survey for early March. It shows manufacturing output expanded in March at a five-month high. However, S&P’s prior surveys consistently pointed to a downturn in overall business, which contradicts other information.
Wednesday’s business surveys of service companies are expected to show continued strength. If these surveys even hint at a slowdown, it will be a positive sign for financial markets.
Friday’s employment report will round out the week. Both the ISM business survey for service companies and weekly data for initial claims point to another relatively strong jobs report. Look for a gain of 200,000 to 250,000 private-sector jobs.
If this week’s data confirm the economy performed well in March, it likely will reverse some of the current expectations for a potential shift to a less restrictive monetary policy.
Money, Money, Money
Federal Reserve data for the end of March show a $322 billion decline in the money supply. Most of the decrease ($280 billion) came from banks increasing their deposits at the Fed. The remainder resulted from the Fed selling securities. With the money supply decline in March, the year-over-year increase in the money supply is only 1 percent.
Monetary policy has become progressively more restrictive.
Stock prices rallied strongly this week, with the S&P500 up 3 percent, holding clearly above its key 200-day average.
The main factor affecting financial markets is the expectation the economy and inflation will retreat enough for the Fed to stop raising interest rates and then signal potential cuts. This is the expectation factored into financial markets.
Friday’s February spending and incomes report showed key measures of inflation in the 3 percent to 4 percent range. Wages and salaries also slowed to the 3 percent to 4 percent annualized range for the month.
February marks the eighth month of monetary restraint. Friday’s report shows the first tentative sign of the slowdown we have been expecting. One month is not significant. However, if the economy already is responding to eight months of monetary restraint, this is just the beginning. The months ahead are likely to show even more signs of a slowdown as we enter a recession.
As mentioned above, monetary restraint increased in March. Given the normal six- to nine-month lag, expect further weakness in the economy through year-end.
We continue to believe the overall banking system is healthy. However, the increase in the regulatory burden on banks is likely to lead to further negative surprises.
Even so, the latest evidence of progress in slowing the economy and inflation, along with somewhat improved technical signals, may give some hope to the markets.
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Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 16 percent
Monetary Policy: restrictive