Confounding US Economic, Inflation Data Cloud Fed's Rate Path

• The Federal Reserve's latest financial stability report was good news for anyone worried that a record run of interest rate hikes might overstress the banking system or trigger a recession with companies and households pushed into default through a broad credit crackdown.
• Instead, the Fed is wrestling with an economy that has sloughed off tight monetary policy to such a degree that U.S. central bank officials are without a clear view of what to expect and are divided over issues like productivity, the economy's underlying potential, and even whether the current policy interest rate is as restrictive as imagined.
• New GDP figures released on Thursday highlighted the dilemma, with the economy growing just 1.6% over the first three months of the year, below expectations, and a marked slowdown from the 3.4% registered in the fourth quarter of 2023. It was the first reading below the Fed's 1.8% estimate of the economy's potential since the second quarter of 2022.
• Stubborn inflation figures are opposing the underwhelming GDP Q1 release, as measured by the personal consumption expenditures (PCE) price index, which came in at 3.4% in the first quarter, well above the Fed's 2% target.
• Across the economy, a wave of tight credit seems to have come and gone - bank lending is growing, corporate credit spreads are narrow, and household balance sheets are largely healthy. A recently updated Fed index of overall financial conditions showed there was virtually no impact on economic growth right now from the central bank's monetary policy or the broader credit conditions it is intended to influence.
• Contrary to Fed officials assessment that policy is restrictive, current credit conditions in the economy are "consistent with above-trend growth. That tells me that the transmission of monetary policy to the real economy in the U.S. has been much less effective" than elsewhere, said Joe Kalish, chief global macro strategist at Ned Davis Research.
• Fed officials themselves are unsettled on whether they still need the economy to slow for inflation to fall or whether the "immaculate" influence of productivity and other factors will do the job, an important issue since one view leans towards tighter policy and the other towards easing. The release of key inflation data on Friday is expected to show the Fed's preferred measure of price pressures remained well above the central bank's 2% target, a possible sign that progress has stalled.

(Source: Reuters)