The Big Picture
Are you surprised by the U.S. economy's resilience? There isn't a uniform answer to that question.
Some would argue they aren't surprised because there is so much fiscal and monetary policy stimulus in the system. Others would argue that they are surprised given that the Federal Reserve raised rates 11 times between March 2022 and July 2023 in its tightening campaign, that inflation pressures have not fully abated, and given the onerous interest rates on credit cards.
The objective fact of the matter is that the U.S. economy has managed to weather the Fed's rate hikes. We will be reminded of that in the coming week when the Advance Q3 GDP report is released.
Casting Judgment
Real GDP increased 1.6% in the first quarter and 3.0% in the second quarter. The current Atlanta Fed GDPNow model estimate for real GDP growth in the third quarter is 3.3%. That is up from an initial forecast of 2.8% on July 26.
The forecast went as low as 2.0% on September 5, but since then a string of economic data has prompted a series of upward revisions.
The August employment report got things started, bumping the estimate to 2.5%. Following the September employment report, the estimate reached 3.3%. It got as high as 3.5% after the September New Home Sales Report before getting dialed back to 3.3% again in the wake of the September Durable Goods Orders Report.
It's not a stretch to say that economists, in general, have expected economic activity to be softer than what the reports have been indicating. We can say that judging by the Citi Economic Surprise Index.
This index represents the sum of the difference between economists' forecasts and the actual economic data. When the reading is above 0, the implication is that economic data is coming in better than expected. The opposite is true with a reading below 0.
To be clear, this isn't a gauge of economic activity, but rather a gauge of how the data are comparing to forecasts. You could see a report, for example, that indicates retail sales were down 0.2%, but if the consensus estimate called for a decline of 0.5%, then that helps this gauge since the report was better than expected, yet it wouldn't be considered a good report from a growth perspective.
What is clear in the chart above is that most of the data since late August has exceeded expectations. Fittingly, that fact lines up well with the progression of the Atlanta Fed GDPNow model estimate. It also lines up reasonably well with the trend in market rates. It's not a perfect fit considering rates didn't start going up steadily until after the Fed cut the target range for the fed funds rate by 50 basis points on September 18.
Both Are Valid
The better than expected economic data have taken a hard landing out of the market's mind, forcing it to think that the economy may not have a landing at all -- soft or otherwise. Consequently, that has led to a recalibration of the number of rate cuts the Federal Reserve might provide, which in turn has been a catalyst for short rates moving higher.
The back end of the yield curve has moved up in part because the growth outlook has improved, fueling concerns about inflation heating up again or at least not improving much further and driving some to think that the Fed's neutral rate will end up higher than the Fed's longer run estimate of 2.9%.
Arguably, another factor driving the rise in Treasury yields after the rate cut is the market's worries about the monstrous national debt. We pointed out in our prior column that the debt stands at 124.3% of GDP and that the plans put forward by both presidential candidates are projected to add $3.5-7.5 trillion more in new debt over the next 10 years, according to the Committee for a Responsible Federal Budget.
There is a festering concern that the rise in Treasury yields could have more to do with the debt issue than it does with the improved economic view. We will humbly concede that both are valid positions and are making the Fed's inclination to cut rates further more challenging and debatable.
A Cut Above the Rest
The U.S. economy is in a good position amongst advanced economies. The IMF certainly sees it that way, having recently released its World Economic Outlook Projections.
For 2024 the IMF sees real GDP growth for the U.S. increasing 2.8% at an annual rate versus just 0.8% for the euro area, 0.3% for Japan, 1.1% for the United Kingdom, and 1.3% for Canada.
The 2025 outlook projects some slowing, but the U.S. still comes out ahead of most with real GDP growth projected to increase 2.2% at annual rate versus 1.2% for the euro area, 1.1% for Japan, 1.5% for the United Kingdom, and 2.4% for Canada.
Separately, the IMF anticipates China's real GDP will increase 4.8% at an annual rate in 2024 and 4.5% in 2025. India's real GDP is projected to grow 7.0% at an annual rate in 2024 and 6.5% in 2025.
It is not an overstatement to say the U.S. economy remains a cut above other advanced economies, which is why it continues to attract foreign capital and why the stock market is handily outperforming stock markets in other advanced economies on a year-to-date basis.
What It All Means
The Federal Reserve is working to avoid the hard landing. Questions remain as to whether it can do that given the lag effect of prior rate hikes. The economic data, however, remains on the Fed's side for the most part, which is exactly what the stock market wants to see.
That preference is apparent in the fact that the S&P 500 and Nasdaq Composite have held near record highs even as market rates have moved up appreciably since the September 18 rate cut. The relative strength implies that the stock market is operating predominately with a belief that the U.S. growth outlook is intact, which in turn makes it believe the earnings growth outlook is intact.
That view makes it all the more important for the economic data to continue to surprise in a good way.
