The economy is on solid footing and optimism is stretching markets to new heights. Against this rosy backdrop, however, challenges linger: inflation is proving stubborn, limiting the scope for Fed rate cuts and putting upward pressure on rates. For investors, balancing the optimism priced into stratospheric valuations is a challenge that may call for alternatives.
Key takeaways
- The economy is coasting on positive momentum, enjoying support from a strong labor. market, wealth gains and improved productivity growth.
- Inflation remains uncooperative and progress has stalled. We are watching commodities particularly closely in Q2.
- The Fed may forge ahead with surgical rate cuts, but we expect long-term rates to continue to drift higher as the yield curve normalizes.
The momentum carrying the economy through the most aggressive rate hike cycle in decades continued in the first quarter of 2024, and at the start of Q2, optimism is everywhere. Since the stock market climbed out of its cycle low in November 2022, economic growth expectations have steadily moved higher and valuations have soared on the back of strong fundamentals.
This optimism is well founded as the economy looks strong. Consumption is still a powerful engine of growth, and real income growth, a strong job market and wealth gains are all pillars of support. The unemployment rate has been below 4% for over two years—for the first time since the late 1960s. The labor data are unambiguously positive. Initial jobless claims hover just above 200,000, a historically low level. Hiring continues to be broad-based with robust job creation, with 829,000 jobs added in the first quarter. The buzzword in labor markets is ”rebalancing” as the churn of job switching slows after COVID distortions, but this should not be confused with labor market weakness. Add it up and this crucial support for the consumer remains rock solid.
GDP data reflects this optimism. After posting 3.1% growth in 2023, output is off to a good start and the Atlanta Fed’s GDP Now estimate at the time of writing is 2.5%. Strong consumption spending, nine quarters of growth in business investment, and the tailwind of government spending all mean Real GDP continues to be on track for above-potential growth in Q2.
