The Federal Reserve delighted markets last week by signaling it will stay the course with interest rate cuts this year. The ensuing batch of economic indicators is starting to challenge that reassuring confidence. The biggie could be this morning’s release of the Fed’s preferred inflation gauge, the PCE price index minus food and energy costs. Per a Bloomberg survey, it’s expected to show a 0.3 percent month-to-month increase for February, following a January uptick that was the largest in a year. It comes on top of other data points from the last few days that may give the Fed pause as it decides when to cut rates. The indicators continue to show that the economy is performing more strongly than expected, despite higher borrowing costs. “I see economic output and the labor market showing continued strength, while progress in reducing inflation has slowed,” Fed Governor Christopher Waller told the Economic Club of New York on Wednesday. “Because of these signs, I see no rush in taking the step of beginning to ease monetary policy.” Ahead of Friday’s inflation report, the week’s big economic data release was the Commerce Department’s final read on gross domestic product for the fourth quarter. At 3.4 percent, it came in higher than the government’s previous estimate, showing that economic output grew even faster at the end of last year. Commerce also said gross domestic income, an alternate benchmark that tallies earned income and costs rather than GDP’s value of goods and services produced, surged by 4.8 percent, the highest rate since the end of 2021. While GDP and GDI are backward-looking, more recent evidence also raises questions about whether the Fed needs to relax rates soon. Financial markets have been soaring, with stocks and bitcoin hitting new records this year. The S&P 500 is having its best first quarter since 2019. The increases have been driven in part by the Fed halting its rate-hike campaign and pivoting to potential cuts. As for the persistently strong labor market, data out Thursday showed that jobless claims last week fell by 2,000 to 210,000. The four-week moving average also fell. An increase in jobless claims would be a sign of economic slowdown. Apollo chief economist Torsten Slok flags a growing tension for the Fed: The “long and variable lags” of the Fed’s rate hikes — moves made to slow the economy enough to tame inflation — have been overwhelmed by the surge in the S&P 500 since November. He cites strong employment growth in January and February, low jobless claims and upward inflation pressure. “The bottom line is that the last mile is harder because of the immediate positive impact on the economy of record-high stock prices,” Slok wrote Tuesday. Other economists — and some Fed officials themselves — cite evidence that indicates the economy is getting to the point where interest rates may need to be dialed back. RSM US chief economist Joe Brusuelas wrote Thursday that his firm’s take on the Taylor Rule — a kind of economic equation designed to help guide rate cut decisions — implies that the Fed should start easing in the near term. At stake, according to Brusuelas, is a potential tip toward higher unemployment and sub-trend growth. It underscores concerns that a Fed decision to keep rates at current levels will have an outsize negative impact on the economy as inflation recedes, with inflation-adjusted “real” interest rates rising. Fed Chair Jerome Powell said last week that central bank officials believe that, overall, financial conditions are ultimately weighing on economic activity. He cited signs in the labor market that demand is “cooling off a little bit from the extremely high levels.” “That's been a question for a while,” he said. “We did see progress on inflation last year, significant progress, despite financial conditions sometimes being tighter, sometimes looser.” What does Powell think now? He’s scheduled to update us on his outlook later this morning, when he appears at a San Francisco Fed conference. Happy Friday — Send tips to zwarmbrodt@politico.com.
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