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What Powell Didn't Say on 60 Minutes


Economics and politics usually go hand-in-hand in a US presidential election year


2024 will be no exception if not more so than usual


The performance of the US economy could decide the outcome of the November election.


But election politicking could also have a huge influence on the performance of the economy before the voting day


Will the economy improve and Biden gets re-elected?


Or will the economy get worse and Trump wins a second term?


If a soft landing is good for Biden and a hard landing is good for Trump, what about a no landing?


Why is the US election both the biggest upside risk and the biggest downside risk for the US economy in 2024?




Economic optimism is in the air


The JP Morgan composite global purchasing managers index picked up again in January, for the third consecutive month. (Chart 1)


It now stands at a 6-month high. (Chart 1)


The slump in global manufacturing since the middle of 2022 appears to have ended (Chart 2)


Global manufacturing PMI is back at 50, its neutral territory (Chart 2)


Global semiconductor sales, usually a reliable leading indicator for the world economy, is growing again after a long dry spell (Chart 3)


If Wall Street has good reasons to be feeling better about the world economy in 2004, it is feeling even better about the US economy


This is evidenced by the fact that the USD is rallying (Chart 4) while the US stock market is outpacing the rest of the world (Chart 5)


Wall Street economists again revised up their forecast of US GDP growth for 2024 last month. (Chart 6)


The consensus forecast for 2024 is now at 1.5%, nearly a full percentage point higher than only 6 months ago (Chart 6)


And the upward revision is set to continue this month, given the blockbuster labor market data in January


Optimism is contagious and self-perpetuating.


But when is too much optimism no longer a good thing?




Wall Street economists don’t like to be wrong and when they are they have a tendency to over-compensate


I was not in the recession camp but even I did not expect the strong acceleration of the US economy in the second half of 2023 (Chart 7)


The 5% GDP growth in the third quarter was a huge surprise (Chart 7)


In some respect, the 3.3% growth in the fourth quarter was even a bigger surprise, because it meant the acceleration was no fluke (Chart 7)


Both Wall Street and the Federal Reserve were taken aback by the economy’s strong finish in 2023.


After the most aggressive interest rate hikes in decades, the economy should be at least slowing down


Larry Summers suggested last week that post-COVID structural changes are raising the so called neutral policy interest rate


Everything looks obvious in retrospect.


What is clear is that even to pretend to have an informed view about the US economy in 2024, we need to first understand what really happened in the second half of 2023.



A major driver of US economic growth in 2023 was government spending.


By government spending I don’t mean big transfers to households like we saw in 2020 and 2021.


I mean actual government consumption and investment, at both the federal and local levels


As you can see on this chart, US government consumption expenditures and investment accelerated sharply last year. (Chart 8)


It grew 4.5% in the second half of the year, the fastest since the pandemic.  (Chart 8)


A big part of the spending was a massive hiring spree by the government. (Chart 9)


Over the past 12 months, the government has added on average 50,000 new workers every month, the fastest in more than 20 years (Chart 9)


As a result, US budget deficit and financing requirement ballooned.


Treasury issuance reached $2.3 trillion in 2023. (Chart 10)


For the full year, government consumption and investment contributed 0.7 percentage points to GDP growth, nearly half of that of household consumption that is 4 times bigger in size (Chart 11)


Of course, 0.7 percentage point is only its direct contribution.


Given the likely multiplier effect, the total contribution of government consumption and investment could easily be more than 1 percentage point, meaning close to a third of GDP growth.


Neither Biden nor Powell would ever mention it but fiscal easing played a big part behind the resilience of the US economy in 2023




I find it somewhat disingenuous that so many Fed officials continue to feign surprise at the apparent insensitivity of the US economy to high interest rates.


This is because they ought to know better.


Everyone knows that monetary policy works its magic through financial conditions


More specifically, an increase in interest rates has a dampening effect on the economy mainly through a tightening of financial conditions.


US financial conditions have been easing since the collapse of Silicon Valley Bank last March, even though the Fed went on to hike two more times. (Chart 12)


Indeed, financial conditions have eased so much over the past 6 months that they are almost as loose now as they were at the start of 2022 before the Fed embarked its hiking cycle


Given the above, I don’t think there is anything mysterious about the insensitivity of the economy to the high Fed Funds rate


If there is any mystery at all it is why financial conditions are not tighter or why the Fed is not more concerned that it is so loose.


For whatever is worth, the easing of financial conditions over the past 3 quarters is the most substantial easing episode that we have seen outside a recession or a major financial crisis in 20 years (Chart 13)


A major part of this easing came from the massive rally in the US stock market of the past year


This has boosted consumer confidence (Chart 14) which in turn has boosted household spending by reducing personal saving rate (Chart 15)


The re-acceleration of the US economy over the past 2 quarters may mean that financial conditions are not only loose but too loose.


What this means is that a further rally of the stock market might carry the seeds of its demise.  




So the resilience of the US economy may not be more remarkable than the result of a combination of easing fiscal policy and easing financial conditions.


But what about the fact that borrowing costs have gone up for hundreds of thousands of companies (Chart 16)?


After all, surely not every company managed to lock in low long-term interest rates during the pandemic.


What about the fact that many of these companies continue to face high nominal wage growth (Chart 17) and rising real wage growth?


How can we square the resilient economy with the headwinds that many companies must be feeling right now?


If the US corporate sector did better than expected in 2023 it had a lot to do with a big jump in labor productivity growth that recovered strongly in the second half of 2023 (Chart 18)


It is difficult to determine what was behind the improvement in productivity, but this helped stave off a bigger drop in corporate profit growth (Chart 19)


Indeed, the increase in labor productivity helped companies absorb higher labor costs without having to resort to big layoffs (Chart 20)


While hiring slowed in 2023, the private sectors still created more than 2 million jobs in 2023.  


I suspect a big part of the improvement in labor productivity came from more companies asking their employees to return to the office, even for 3 days a week.


Whether labor productivity growth can remain in 2024 at the 2% rate like we saw in the second half of 2023 will have huge implications for the outlook for both the economy and the stock market in particular.




Other than fiscal easing, easing of financial conditions, and a productivity boost from at least partial return to the office, there was another important positive tailwind that contributed to the average 4.1% GDP growth in the second half of 2024.


A sharp decline in energy price.

Average national gasoline price dropped a whopping 20% in the final 3 months of the year.  (Chart 22)


This boosted the real purchasing power of households and helped ease inflation pressure.


This was the most important factor behind the sharp drop of quarterly growth rate of the GDP deflator from 3.3% to just 1.5%.


As I have explained in previous videos, the sharp decline in oil price is largely the result of two developments:


1.     A sharp increase in US oil production from August onwards (Chart 23)

2.     An equally sharp increase in Iranian oil exports as the Biden administration stopped enforcing the existing oil sanctions on Iran (Chart 24)


I remain of the view that getting macro right in 2024 means getting oil right. Getting oil right means getting Iran right.



In my view, the strong finish of the US economy in 2023 was due to a confluence of factors that are difficult to repeat in 2024:


1.     With the gridlock in Washington, there is zero scope for fiscal easing. There is a chance that a child tax credit bill, already passed by the House, will get through the Senate and become law (Chart 25). But that is not a given. $79bn could move the needle for the overall economy but not by very much.

2.     With financial conditions very loose and the labor market very tight, the risk is that inflation gets stuck before it returns to 2%. (Chart 26)

3.     Increased geopolitical risks are already unleashing new negative supply shocks. Freight rates have soared as the result of continued Houthi attacks in the Red Sea (Chart 27). Front-month crude oil contracts have traded back above 75 a barrel, from a low of $68 a barrel in December. (Chart 28) All these developments will make it more difficult for the Fed to cut interest rates

4.     The US stock market has never been more expensive since the dot com bubble (Chart 29). If Treasury yields back up because the Fed is held back by stickier than expected inflation, the equity market could be in for a wild ride.

5.     Of course, there is also the election to consider. Markets don’t like uncertainties and there will be a lot of uncertainties that will make the 2020 election look like a walk in the park. How will corporations respond to these uncertainties? The latest Business Roundtable survey tells us that capex spending will likely decline this year. This could affect hiring too. This means the closer we get to the election, let’s say from May onward, the animal spirit will be replaced by risk aversion.


I don’t know how long the current feel good, nothing can go wrong mentality in the market will last.


I would be very surprised if we don’t get a meaningful equity correction before the end of the first quarter.


But I think the economy will do worse in the second half of the year than in the first half.


All else being equal, that should give Trump an edge on November 5.


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Hi David, what makes you feel that there would be a meaningful correction before the end of Q1?

What I know is that there is a lot of money waiting to be deployed by large asset management and sovereign wealth fund, who didn’t invest last year because like everyone they thought 2023 would be a recession year. Now given their massive underperformance to the benchmark, they are under intense pressure to fully deploy their assets. I believe some of them are still waiting for a dip. They will implicitly provide some protection to the downside.

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We shall see. After a big rally we usually get a meaningful correction. We won't be getting ahead of ourselves. The model will tell us when to move to the sideline


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