The first week of May brought a deluge of economic data, including the April jobs report, key surveys on business activity, and some important readings on inflation. Add in a Federal Reserve (Fed) policy meeting, and it’s fair to say that the most important week of economic data in May is already behind us. Looking at these reports together, the economy still appears to be in an economic sweet spot, producing solid growth but not enough to cause us concern about an overly aggressive Fed. Rates will still push higher at a moderate pace and it’s natural for financial conditions to tighten as we move later into the economic cycle, but as long as these are driven by steady economic growth with a minimal build-up of excesses, we expect the economic expansion to continue largely uninterrupted.
FED HOLDS STEADY
The Federal Reserve completed its third of eight scheduled two-day policy meetings on May 2, 2018. As was widely expected, the Fed maintained the fed funds target rate range at 1.50–1.75% after raising rates at its previous meeting in March. The May meeting did not include updated economic projections nor was it followed by a press conference by Fed Chair Jay Powell, so all Fed watchers were given to digest was the relatively brief policy statement.
The few changes in the statement signaled a slightly more upbeat assessment of the economy, highlighting strong growth in business fixed investment. There was also an acknowledgment that inflation was essentially at the Fed’s 2% target, rather than running below it. In doing so, it characterized its inflation target as “symmetric,” a new wrinkle and a reminder that running a little above the rate would not in itself be sufficient for the Fed to raise rates more quickly. Overall, the statement did little to change policy expectations. The Fed remains on track to raise rates two to three more times in 2018, with odds of a hike at the June meeting already almost fully priced in.
INFLATION MOVES CLOSE TO 2%
Earlier in the week, the Bureau of Economic Analysis released the monthly reading of personal consumption expenditure (PCE) inflation. The Fed’s favored measure of inflation, the core version of this reading (which excludes volatile food and energy prices), showed an increase of 0.2% month over month, and 1.9% year over year, edging closer to the Fed’s 2% target.
The moderate increase in inflation in recent months has led to a slight increase in the market’s rate hike expectations, with fed fund futures markets now evenly split between two and three additional rate hikes in 2018, for a total of three or four over the entire year. Even four hikes would only mean an average of one rate hike every other meeting, which pales in comparison to a hike at 17 consecutive meetings from 2004–2006, prior to the Great Recession. This debate between two or three more hikes will go on, but it is important to remember the bigger picture—the fed funds rate at 1.75% remains low relative to history (average is 5.25% since 1971, and 3.67% since 1985) and is unlikely to cause major problems for the economy regardless of whether we get a total of three or four hikes this year.
HEALTHY JOB MARKET BUT WITH LITTLE ADDED PRESSURE ON THE FED
The closely watched nonfarm payrolls report (released on Friday, May 4) showed the U.S. economy created fewer jobs than expected (164,000 versus 190,000), but the overall employment level ticked higher as the labor force participation rate fell to 62.8, pushing the unemployment rate to an 18- year low of 3.9%; March’s initial figure was revised up by 32,000 to 135,000, basically offsetting the miss in expectations.
Job growth has slowed since its peak in 2015, but is still very healthy for this point in the economic cycle and has shown recent stabilization. Wages grew 0.1% month over month in April, slightly below expectations of 0.2% growth, to put year-over-year wage growth at 2.6%, ahead of inflation but still signaling only modest signs of wage pressure.