Federal Reserve Chairman Jerome Powell has often defended the central bank's long string of rate hikes, alongside the sale of billions in Treasury bonds, on the basis that the economy, and the job market is particular, is strong enough to absorb them.
Powell, in fact, told the Economic Club of Washington, D.C. earlier this month that the labor market is "incredibly strong ... certainly stronger than anyone expected" and warned that "if we continue to get strong labor market reports or higher inflation reports, it might be the case that we have to raise rates more" than is now expected."
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Bond markets, while recently embracing the Fed's hawkish rate signaling, have nonetheless been flashing their classic recession warning signal for nearly a year, with 2-year Treasury not yields rising above 10-year yields in March of 2022, amid concerns that the Fed's policy tightening will snuff-out any hopes of a sustained post-pandemic recovery.
And yet, with around 450 basis points of interest rate hikes last year, billions in quantitative tightening and endless "were we/were we not in recession" debates, the U.S. economy continues to defy gravity.
The Commerce Department's second estimate of fourth quarter GDP was trimmed to 2.7% Thursday, thanks in part to a smaller-than-expected contribution from consumer spending, but is still running above the longer-term 2.1% pace projected by the Bureau of Labor Statistics.
The Atlanta Fed's GDPNow forecasting tool suggests the economy is expanding at a 2.5% over the current quarter, while the final GDP tally for the three months ending in October was pegged at 3.2%.
The fourth quarter reading of the Fed's preferred inflation gauge, meanwhile, was revised higher -- to 4.3% from 3.9% -- suggesting the chances of a faster-than-expected reading for the January PCE Price Index, which is published on Friday, has also accelerated.
Mike Loewengart, the head of model portfolio construction at Morgan Stanley Global Investment Office, says the data is a "reminder that parts of the economy remain relatively strong amid high inflation and aggressive rate hikes."
"While Q4 GDP ticked down slightly from its first estimate, it still shows the economy is expanding," he said. "Though that’s not to say it’s all rosy as inflation’s downward trend seems to have hit a few bumps, and that combined with a tight labor market, could be the recipe the Fed needs to keep raising rates."
The economy's resilience, in fact, has been no more evident than in the job market, where unemployment sits at the lowest levels in more than five decades and an estimated 11 million positions were left unfilled over the month of December.
This week data from the BLS showed application for new jobless benefits fell by around 3,000, to 192,000, even amid the rolling headlines of big tech sector layoffs, prompting analysts to recalibrate their estimates for February payroll gains following January's blowout 517,000 tally.
The figures put yesterday's Fed minutes, which detailed the debate that formed its decision to lift its benchmark interest rate by 25 basis points on February 1, in a new and potentially market-changing context.
"Several participants noted that recent reductions in the workforces of some large technology businesses followed much larger increases over the previous few years and judged that these reductions did not appear to reflect widespread weakness in the demand for labor," the Minutes read.
“Participants judged that as long as the labor market remained very tight, wage growth in excess of 2% inflation and trend productivity growth would likely continue to put upward pressure on some prices in (core consumer prices)," the Minutes added.
Thus far, however, bond markets and rate traders haven't fully embraced the change; bets on a 50 basis point rate hike in March have inched higher, to around 27%, with wagers -- albeit small -- emerging on a Fed Funds rate that will top out at between 5.5% and 5.75% by mid-summer, according to figures from the CME Group's FedWatch.
Benchmark 10-year note yields, which jumped to as high as 3.96% in early Thursday trading, have retreated to around 3.908% while 2-year notes are were last seen trading at 4.679%.
Stocks, however, appear a bit more sensitive, with the S&P 500 giving back earlier session gains to trim its year-to-date advance to around 3.8% heading into tomorrow's inflation reading and could begin to suggest deeper Fed rate cuts even as bonds resist breaching the psychologically important 4% threshold on 10-year note yields.
"The Minutes emphasized that the Fed wants to make monetary policy “sufficiently restrictive” to return a more normal degree of slack to the labor market and reduce trend inflation," said Bill Adams, Chief Economist for Comerica Bank in Dallas, who forecasts three more 25 basis point rate hikes between now and June. "However, the Fed could surprise to the upside again in inflation slows less than expected or the unemployment rate falls further."
Jeffrey Roach, however, chief economist for LPL Financial in Charlotte, North Carolina, thinks that while the PCE data will be crucial to the Fed's outlook, calls for a 50 basis point rate hike in March are likely "overdone".
"The FOMC is hotly debating the risks to the inflation outlook while being more in agreement on the downside risks to economic growth," he said. "Therefore, the Committee will likely maintain the 25 basis point cadence at next month’s meeting."
