What Next for the Global Economy?

A strategy that's delivered specialist investors huge returns is now facing scrutiny, amid concerns that its risk-reward dynamics might be skewed against some issuers.

Catastrophe bonds, which are issued by insurers, reinsurers and governments seeking an extra layer of disaster coverage, have been handing investors double-digit returns. Issuers, meanwhile, have seen their costs soar.

Grievances surfaced in July, after it emerged that Jamaica's catastrophe bond wasn't triggered by the devastation wrought by hurricane Beryl. Though the entire Caribbean island was officially declared a disaster area, the carefully calibrated terms of the bond meant its holders were shielded from losses. In the event, it was decided that the precise level of air pressure required for a payout wasn't achieved.

For cat bond investors — who are currently reaping an average return of around 15% after raking in 20% in 2023 — the outcome in Jamaica underpins the appeal of a strategy that's attracted some of the brightest minds in finance. For others, it's set off a difficult debate.

Caribbean heads of government within the group known as Caricom recently discussed the financial ramifications of Beryl. This month, the group said it will be seeking "an examination" of cat bonds and other insurance-linked securities, and wants the region's finance ministers to take a closer look at which markets governments should choose and which they should avoid.

"We recognise that at the end of the day, investors need to make returns," Jwala Rambarran, a former governor of the central bank of Trinidad and Tobago, said in an interview. "But at the same time, fairness and equity says it can't be all the time that the investors are making the returns. It's a one-way street."

The Jamaican Ministry of Finance didn't respond to requests for comment.

The country's US$150 million (RM657.4 million) cat bond — arranged by the World Bank and bought by private investors — was issued this year to replace a 2021 bond. The new bond costs the government 60% more per unit of coverage, which reflects the heightened risk posed by climate change as well as higher reinsurance costs, according to Conor Meenan, a risk finance specialist at the London-based Centre for Disaster Protection.

Cat bonds make it possible for issuers (also referred to as sponsors) to pass part of their risk over to capital markets. Sales of the instruments have soared lately, with factors including climate change, population density and inflation adding to their appeal. Investors face potentially substantial losses if a bond is triggered, but can generate market-beating returns if a predefined catastrophe doesn't occur.

For the US$47 billion cat bond market, Beryl proved an early win for investors navigating their way through a hurricane season that's expected to be unusually active.

Zurich-based Plenum Investments AG, one of the private-market buyers of Jamaica's cat bond, said it was drawn to the opportunity to diversify away from the US market. "We also like the parametric trigger structure, which minimises uncertainty post event," Plenum said in an emailed response to questions.

Issuers turning to cat bonds get a very specific type of coverage whose terms should be clear to all stakeholders at the point of purchase, according to the World Bank.

Cat bonds are "for tail events," which are rare disasters outside the norm, said Michael Bennett, head of derivatives and structured finance at the World Bank treasury. "The parameter isn't the fine print, it is the print."

In the case of Jamaica, Beryl very narrowly missed hitting the parameter that would have caused the bond to pay out. The pressure reading "was one or two millibars too high in one or two zones," said Robert Muir-Wood, chief research officer in insurance solutions at Moody's. "It was a very close call."

Rambarran, the former Trinidad and Tobago central banker, recently co-authored a report by the Vulnerable Twenty Group — or V20 — which represents countries who are among the world's most exposed to climate change. V20 says it's time to overhaul the triggers that determine whether a cat bond investor will be called on to cover losses. The group's concern is that thanks to skillful financial engineering, such triggers are becoming increasingly narrow and rigid.

In the case of Jamaica's cat bond, investors were protected because the conditions for triggering a payout "are hard and specific," the V20 report said. "This rigidity protects investors but leaves Jamaica vulnerable to catastrophic risk."

The parameters that determine cat-bond payouts are unlikely to become softer in the future, according to analysts monitoring the market.

"We expect cat bonds to adjust the triggering criteria for a payout to cover only the most severe types of storms," said Morgan Stanley strategists including Carolyn  Campbell. "The parametric bounds of today might become too common in 10 years; cat bonds of the future are likely to cover only those rarest, most damaging storms, with a frame of reference evolving constantly."

Sara Jane Ahmed, managing director and finance adviser to the V20 group and the report's lead author, says it's "clear that we need a lot more financial protection triggers that are reliable and timely."

The "disappointing" payout outcome of Jamaica's cat bond underscores the need for the World Bank "to reassess the usefulness of this complex and costly financial instrument and even perhaps for Jamaica to renegotiate the terms of its cat bond," the report concluded.

But designing cat bonds with lower trigger thresholds would only drive up the price, according to the World Bank.

"If you want these bonds to pay out more frequently, you'll be charged more in premiums," said George Richardson, director of capital markets and investments at the World Bank treasury. "There's a trade-off to be considered."

Aside from Jamaica, investors were spared losses on cat bonds in Mexico and Texas, which were also hit by Beryl. Other forms of disaster insurance did pay out, however. The Caribbean Catastrophe Risk Insurance Facility, or CCRIF, disbursed a record US$44 million to Grenada due to Beryl's destruction. CCRIF also delivered smaller payouts to other Caribbean nations, including Jamaica.

And with a total disaster safety net of US$1.6 billion, Jamaica is particularly well-insured against the threat of hurricanes, according to Meenan. "They're taking risk very seriously," he said.

The Philippines chose not to renew its cat bond when it lapsed in 2022, favoring an indemnity insurance program. Bennett at the World Bank, which helped arrange the country's catastrophe risk insurance, says the government in Manila is still "considering cat bonds as part of their larger insurance strategy."

Ahmed of the V20 group says that "as development partners think about their role in this climate crisis, part of that is really taking a hard look at some of these products." And then "figuring how do we make them fair," she said.

The first Bank of England rate cut in four years has triggered an immediate upturn in the UK property market, as cheaper mortgages prompt interest among buyers and drive up house prices.

Figures from the property website Rightmove show the number of potential buyers contacting estate agents about homes for sale since 1 August jumped by 19% compared with the same time a year ago. Contacts in July were up 11% on the previous year.

The Bank cut interest rates on 1 August for the first time since the start of the Covid pandemic, easing pressure on households after it had raised borrowing costs to the highest level since the 2008 financial crisis to tackle soaring inflation.

It cut its key base rate from 5.25% to 5%, after a fall in inflation back to more normal levels this year. Figures last week showed inflation rose to 2.2% in July, above the Bank’s 2% target. However, it remains significantly lower than a peak of 11.1% two years ago after the Russian invasion of Ukraine triggered a surge in energy prices.

Rightmove said the Bank cutting borrow costs had helped to accelerate the availability of cheaper mortgages from high street lenders, alongside contributing “significantly” to improved buyer demand.

It said future Bank rate cuts would establish a buoyant autumn property market, and it upgraded its house price forecasts from a 1% drop over the whole of 2024 to a 1% rise in new seller asking prices.

Financial markets widely expect that the Bank will react to fading inflationary pressures by cutting rates further, possibly to as low as 3.5% by the end of next year. The Bank is expected to keep rates on hold at its next meeting in September before restarting reductions in borrowing costs in November.

Andrew Bailey, the Bank’s governor, is expected to speak at the annual US gathering of central bank policymakers at the Rocky Mountains resort of Jackson Hole on Friday.

Rightmove said the average new seller asking price had fallen this month by 1.5%, or by £5,708, to £367,785. Prices typically fall in August from July during the quieter months for the property market. The fall was in line with the long-term average for the last 18 years.

“As the summer holiday season comes to an end, the conditions are there for a more active autumn market,” said Tim Bannister, Rightmove’s director of property science. “The reaction from home-movers to what is hopefully only the first of several rate cuts over the next year or two, combined with other positive data and trends, has led us to raise our price prediction for the year.”

The figures come as high street lenders reduce the borrowing costs on new mortgages in anticipation of the central bank lowering interest rates. Rightmove said the average five-year fixed-rate mortgage was now 4.80% – still higher than three years ago, before the first of 14 consecutive Bank rate increases, but significantly down from 5.82% at this point in 2023.

The latest figure is the lowest since around Liz Truss’s mini-budget in September 2022.

Estate agents said that alongside the Bank cutting rates, increased political certainty after Labour’s general election landslide in July and a brighter economic outlook were also helping with buyer interest.

Josephine Ashby, a managing partner at John Bray Estate Agents in Cornwall, said: “There is no doubt that activity slowed in the buildup to the general election despite a result that was no great surprise to the country. With the election now behind us we are seeing an improvement in buyer engagement as more certainty in the political and economic landscapes forms.”

However, borrowing costs are still higher than three years ago, while housing affordability remains stretched for millions of families.

Tom Bill, the head of UK residential research at Knight Frank, said: “Markets are pricing in a further cut in 2024, which means transaction volumes should be stronger this autumn than last year. That said, uncertainty surrounding the budget and wave of people rolling off favourable mortgage deals will keep a lid on price growth, which we expect to be 3% in the UK this year.

September S&P 500 E-Mini futures are down -0.02%, and September Nasdaq 100 E-Mini futures are down -0.21% this morning as investors looked ahead to the release of the minutes of the Federal Reserve’s latest policy meeting, Fed Chair Jerome Powell’s speech at Jackson Hole, and earnings reports from a diverse group of prominent companies.

In Friday’s trading session, Wall Street’s major averages ended in the green, with the benchmark S&P 500 and blue-chip Dow rising to 2-week highs and the tech-heavy Nasdaq 100 climbing to a 3-week high. H&R Block surged over +12% after the tax preparation company reported upbeat Q4 results, provided an above-consensus FY25 forecast, and announced a new $1.5 billion share repurchase program. Also, Coherent climbed more than +7% after the company reported better-than-expected Q4 results and issued solid Q1 revenue guidance. In addition, Fox Corp. gained over +1% after Wells Fargo double-upgraded the stock to Overweight from Underweight with a price target of $46. On the bearish side, Applied Materials fell more than -1% after giving an in-line Q4 net sales forecast that disappointed investors looking for a bigger payoff from AI spending. 

Economic data on Friday showed that the University of Michigan’s U.S. consumer sentiment index stood at 67.8 in August, stronger than expectations of 66.7. At the same time, U.S. July housing starts fell -6.8% m/m to a 4-year low of 1.238M, weaker than expectations of 1.340M. In addition, U.S. building permits, a proxy for future construction, fell -4.0% m/m to a 4-year low of 1.396M in July, weaker than expectations of 1.430M.

Chicago Fed President Austan Goolsbee supported rate cuts on Friday after noting that the U.S. labor market and some leading economic indicators are showing warning signs and expressing concerns that unemployment will continue to increase. Goolsbee stated that the speed of transmission of lower rates would “depend on many factors” and indicated his support for a “gradual” rather than rapid pace of rate cuts.

U.S. rate futures have priced in a 71.5% chance of a 25 basis point rate cut and a 28.5% chance of a 50 basis point rate cut at September’s monetary policy meeting.

In other news, Goldman Sachs over the weekend reduced the probability of a U.S. recession in the next year to 20% from 25%, citing last week’s healthy economic data.

Meanwhile, Fed Chair Jerome Powell is scheduled to deliver the keynote address at the central bank’s annual economic symposium in Jackson Hole, Wyoming, on Friday. Market participants will be keenly focused on what he indicates about the pace and timing of rate cuts in the coming months. Earlier in the week, Fed Governor Christopher Waller, Fed Vice Chair for Supervision Michael Barr, and Atlanta Fed President Raphael Bostic will be making appearances.

“We look for Powell to signal that given recent progress, the Fed is likely to ease policy next month - without fully committing to the size of the rate cut. We expect a 25 basis-point reduction.” according to TD Securities’ strategists.

Investors will also be monitoring a spate of economic data releases this week, including the U.S. S&P Global Composite PMI (preliminary), S&P Global Manufacturing PMI (preliminary), S&P Global Services PMI (preliminary), Crude Oil Inventories, Initial Jobless Claims, Existing Home Sales, Building Permits, and New Home Sales.

Retailers Lowe’s, Target, TJX, and Ross Stores, along with notable tech players such as Zoom Video, Snowflake, Palo Alto Networks, Workday, and Analog Devices, are among the prominent companies set to release their quarterly results this week.

In addition, market participants will pay close attention to the publication of the Federal Reserve’s minutes from the July meeting on Wednesday, during which Fed Chair Jerome Powell acknowledged progress on inflation and left the door open for a rate cut in September.

Today, investors will focus on the U.S. Conference Board Leading Index, set to be released in a couple of hours. Economists expect July’s figure to be -0.4% m/m, compared to the previous number of -0.2% m/m.

In the bond market, the yield on the benchmark 10-year U.S. Treasury note is at 3.868%, down -0.70%.

The Euro Stoxx 50 futures are up +0.09% this morning, taking a breather after last week’s rally, as investors braced for a data-heavy week, with a focus on Fed Chair Jerome Powell’s speech at Jackson Hole. Mining stocks outperformed on Monday, while defense and energy stocks lost ground. Meanwhile, investors are awaiting the latest FOMC minutes and a speech by Fed Chair Jerome Powell at Jackson Hole, Wyoming this week to gain further clarity on the outlook for rate cuts. Flash Purchasing Managers’ Index data for France, Germany, Britain, and the Eurozone, along with the U.S. PMI and initial jobless claims data, will also be monitored by investors this week. In corporate news, Rheinmetall Ag slumped over -3% following a report that Germany will not approve new requests for aid to Ukraine as the government aims to curb spending. Also, Nexans fell more than -3% after Goldman Sachs downgraded the stock to Neutral from Buy.

The European economic data slate is mainly empty on Monday.

Asian stock markets today settled mixed. China’s Shanghai Composite Index (SHCOMP) closed up +0.49%, and Japan’s Nikkei 225 Stock Index (NIK) closed down -1.77%.

China’s Shanghai Composite Index closed higher today as risk sentiment improved, while investors continued to evaluate the nation’s economic outlook. Bank stocks led the gains on Monday. Meanwhile, investors await the People’s Bank of China’s decision on its one-year and five-year loan prime rates on Tuesday. Authorities are anticipated to maintain the loan prime rates unchanged after the PBOC pledged last week to implement further steps to support economic recovery while cautioning against adopting “drastic” measures. In other news, China’s stock exchanges have stopped the real-time data feed on foreign inflows into onshore equities starting Monday. The Shanghai and Shenzhen exchanges will now publish select figures - turnover, number of trades, and top 10 traded stocks via the northbound link of the Stock Connect scheme - only once a day after the close of trading, as per their statements. In corporate news, JD Health International surged about +8% in Hong Kong as unexpectedly strong results from JD.com last week boosted sentiment about the group. Investors will be watching Chinese automakers this week, including Xpeng Inc., Geely Automobile Holdings Ltd., and Xiaomi Corp., all of which are expected to report higher vehicle sales.

Japan’s Nikkei 225 Stock Index closed lower today, snapping a five-session winning streak due to profit-taking and pressure on equities from a rallying yen. Energy and consumer cyclical stocks led the declines on Monday. Data from the Cabinet Office revealed on Monday that Japan’s core machinery orders, which exclude those for ships and electric power companies, increased more than expected in June compared to the previous month, marking the first rise since March. Meanwhile, Bank of Japan Governor Kazuo Ueda is set to attend a special session at parliament this week to discuss the July 31st interest rate increase, which unsettled global markets. The Japanese yen climbed for a second session on Monday to trade at around 146 per dollar. Hedge funds have become bullish on the nation’s currency for the first time since 2021, marking a significant shift from the extremely negative sentiment that prevailed as recently as early July. In corporate news, Seven & I Holdings soared over +22% after the Nikkei newspaper reported that the company had received a non-legally binding takeover offer from Canada’s Alimentation Couche-Tard. Market participants are now awaiting Japanese inflation figures due Friday to gain insight into the Bank of Japan’s monetary policy trajectory. The Nikkei Volatility, which takes into account the implied volatility of Nikkei 225 options, closed up +11.23% to 29.52.

The Japanese June Core Machinery Orders arrived at +2.1% m/m and -1.7% y/y, compared to expectations of +0.9% m/m and +1.8% y/y.

FuboTV climbed over +16% in pre-market trading, extending Friday’s gains, after a federal judge temporarily halted the launch of a competing sports streaming service.

HP Inc. fell about -2% in pre-market trading after Morgan Stanley downgraded the stock to Equal Weight from Overweight.

Dutch Bros slid more than -2% in pre-market trading after Piper Sandler downgraded the stock to Neutral from Overweight.

Sweetgreen dropped over -3% in pre-market trading after Piper Sandler downgraded the stock to Neutral from Overweight.

For a second consecutive month in June, sales in the motor vehicle and motor vehicle parts and accessories subsector (-2.6% to $14.2 billion) drove declines in wholesale trade. As in May, sales fell in all three industry groups in June with the largest decline coming from motor vehicle merchant wholesalers (-2.7% to $11.5 billion).

Sales in the machinery, equipment and supplies subsector decreased as well for the second consecutive month, down 0.5% to $17.9 billion in June, as the farm, lawn and garden machinery and equipment industry group registered a large decline (-12.7% to $2.5 billion).

In June, eight provinces reported lower wholesale sales, led by Ontario (-1.1%) and Alberta (-1.0%). In contrast, British Columbia (+2.2%) posted the largest increase.

Wholesale sales in Ontario fell 1.1% to $43.0 billion in June, registering its fifth monthly decline since the beginning of the year. Sales dropped in five of the seven subsectors, mainly driven by the building material and supplies (-5.7% to $4.7 billion) and motor vehicle and motor vehicle parts and accessories (-1.8% to $10.2 billion) subsectors.

Sales in Alberta declined 1.0% to $9.1 billion in June, the second consecutive monthly decline, mainly due to lower sales in the miscellaneous (-9.9% to $994.9 million) and machinery, equipment and supplies (-2.4% to $3.1 billion) subsectors.

On the other hand, in British Columbia, wholesale sales rose 2.2% to $7.8 billion in June, on higher sales in the miscellaneous (+12.8% to $1.2 billion) and building material and supplies (+5.7% to $1.9 billion) subsectors.

Wholesale inventories edged down 0.1% to $126.8 billion in June, following a 1.2% increase in May, and remain at high levels.

In June, four out of the seven subsectors recorded declines, led by the machinery, equipment and supplies subsector (-0.7% to $38.8 billion), as three of its four industry groups posted declines in inventories. Declines were also reported in the personal and household goods subsector (-0.5% to $20.3 billion), where three out of its five industry groups declined.

Inventory gains in the building material and supplies (+0.8% to $22.2 billion) and miscellaneous (+1.1% to $15.1 billion) subsectors moderated the drop in June.

The inventory-to-sales ratio rose from 1.53 in May to 1.54 in June. This ratio is a measure of the time (in months) required to exhaust inventories if sales were to remain at their current levels.

In the second quarter, wholesale sales increased by 0.7% to $249.3 billion, primarily as a result of higher sales in April.

Leading the increase in sales in the second quarter was the personal and household goods subsector, up 2.3% to $37.0 billion, followed by the machinery, equipment, and supplies subsector, up 1.5% to $54.0 billion.

Gains in the second quarter were dampened by lower sales in the building materials and supplies subsector, which decreased 2.4% to $34.6 billion.

Sales in the second quarter of 2024 were 1.4% above those from the same quarter last year.

Manufacturing sales decreased 2.1% to $69.6 billion in June, on declines in 17 of 21 subsectors, led by the transportation equipment (-2.9%), chemical product (-5.8%) and primary metal (-2.7%) subsectors. On a quarterly basis, total sales fell 0.3% in the second quarter of 2024, the third consecutive quarterly decline. The decline in the second quarter was driven by lower sales in the petroleum and coal product subsector (-4.0%) as well as the motor vehicle industry group (-3.8%). On a year-over-year basis, total sales decreased 1.8% in June.

Total sales in constant dollars fell 2.1% in June, while the industrial product price index was unchanged.

Sales in the transportation equipment subsector declined 2.9% to $11.0 billion in June, following two consecutive monthly increases. The decline was widespread, as six of seven industry groups posted lower sales, led by motor vehicle parts (-5.6%) and aerospace product and parts (-2.9%). Retooling in some auto assembly plants in the United States impacted major motor vehicle parts production in Canada and was partially responsible for the lower sales in this industry group. The exports of motor vehicles and parts declined 3.9% in June.

In the aerospace product and parts industry group, production decreased 2.9% to $2.6 billion in June, after it reached its highest level on record in May. Despite the monthly decline, production of aerospace products and parts was up 1.8% in the second quarter.

Sales of chemical products fell 5.8% to $5.2 billion in June, the second consecutive monthly decline and the lowest level recorded since June 2021. The decline was driven by lower sales of pesticide, fertilizer and other agricultural chemicals. Sales of fertilizers typically decline in June, following the planting season in May. Prices of fertilizers, pesticides and other agricultural chemical products decreased 0.1% in June 2024. On a yearly basis, total sales of chemical products declined 4.6% in June, while they were down 1.1% in the second quarter.

Following three consecutive monthly increases, sales of primary metals declined 2.7% to $5.5 billion in June, mainly attributable to lower sales of non-ferrous metal (except aluminum) production and processing. Sales of primary metals in constant dollars declined 2.9% in June. Several shutdowns at some Canadian non-ferrous metal plants contributed to the lower sales observed in June. The prices for several non-ferrous metals declined in June, including unwrought nickel and nickel alloys (-10.3%) as well as unwrought copper and copper alloys (-4.5%). Despite the monthly decline in June, sales of primary metals on a quarterly basis (+4.7%) marked the largest increase among the 21 subsectors in the second quarter.

Manufacturing sales fell in eight provinces in June. The largest declines were posted in Quebec, Ontario and Alberta, while the largest increase was in New Brunswick.

In Quebec, sales decreased 3.2% to $17.8 billion in June, largely on lower sales of primary metals (-7.4%) and fabricated metal products (-9.2%). The decline in the primary metal subsector was the main contributor to the 5.7% decrease in total sales in Montréal. Despite the month-over-month decline, total sales in Quebec were up 3.8% compared with June 2023 and increased 1.6% in the second quarter of 2024.

Following two consecutive monthly increases, sales in Ontario fell 1.7% to $30.7 billion in June, driven by lower sales of motor vehicle parts (-5.9%) and machinery (-5.5%). Sales in Ontario were 7.1% lower on a yearly basis in June, while they declined 1.2% over the second quarter.

In Alberta, sales fell 2.5% to $8.4 billion in June, mainly on lower sales in the chemical product (-7.3%) and machinery (-11.6%) subsectors. Lower sales of chemical products also contributed to the 0.5% decline in total sales in Edmonton. Despite the monthly decline, sales in Alberta were up 6.5% year over year in June and rose 0.5% over the second quarter.

Total inventory levels edged up 0.1% to $121.1 billion in June, on higher inventories in 13 of 21 subsectors, led by chemical (+6.6%) and wood products (+1.6%). The gains were partially offset by lower inventories in the transportation equipment (-2.6%) and miscellaneous manufacturing (-9.9%) subsectors. Higher inventories of finished products (+2.3%) were partially offset by lower raw materials (-0.9%) and goods in process (-1.0%) inventories.

The inventory-to-sales ratio increased from 1.70 in May to 1.74 in June. This ratio measures the time, in months, that would be required to exhaust inventories if sales were to remain at their current level.

Total unfilled orders fell 0.8% to $105.1 billion in June, primarily on lower unfilled orders in the aerospace product and parts industry group (-1.4%).

The capacity utilization rate (not seasonally adjusted) for the total manufacturing sector rose from 79.7% in May to 80.2% in June, mainly on higher capacity utilization rates in the petroleum and coal product (+5.2 percentage points) and transportation equipment (+4.1 percentage points) subsectors. The increase was partially offset by lower capacity utilization rates in the chemical (-3.4 percentage points) and primary metal (-1.6 percentage points) subsectors.

The economy is expected to lose momentum in H2 2024 as high prices and elevated interest rates sap domestic demand. Real GDP growth rose by an unexpected 2.8 percent quarterly annualized in Q2 2024 (from 1.4 percent in Q1 2024), led by stronger domestic demand and a surge in inventories. But there were some signs of weakness, especially as consumers dialed back on services spending, which has been a key contributor to real GDP growth over the last two years. Consumers and businesses are likely to continue cutting spending and investments ahead,  suggesting economic growth decelerated to 0.6 percent annualized in Q3 2024.

GDP growth probably will be lackluster in Q4 2024, expanding at a tepid pace of about 1 percent annualized. The slightly faster pace relative to Q3 reflects some expectation that falling mortgage rates might stoke modest increases in home sales, and a cheaper US dollar supports slightly faster exports growth. However, growth should rise slightly above 2 percent by the end of 2025, reflecting achievement of the Fed’s 2-percent inflation target, and lower interest rates.

US consumer spending was robust in 2023 but was mixed in the first half of 2024 as pandemic savings ran dry, and high prices and interest rates drained wallets.  Real consumer spending on durable goods collapsed in Q1 but rebounded in Q2, probably as costs for big ticket items like cars and furniture started falling in earnest. However, goods spending growth netted out to 0.2 percent annualized in H1. Nondurable goods consumption rose by just 0.3 percent annualized in H1. Meanwhile, services spending was strong in Q1 but slowed by a full percentage point in Q2, averaging about 2.8 percent in H1. Importantly, consumers are still spending, but their purchases are rotating towards cheaper and necessary goods and services.   The Conference Board Consumer Confidence Survey suggests continued concerns among consumers about the future, portending further weakness in spending for the balance of 2024. Consumer spending may pick back up in 2025 as lower interest rates and inflation will grant consumers relief.

Real consumer spending growth is still hovering slightly above real disposable personal income growth meaning some households continue to finance purchases with debt, as excess savings has evaporated. Consumer credit and debt service payments are still mounting, which combined with the high cost of living and elevated interest rates, may also curb expenditures on discretionary items. Auto loan and credit card delinquencies are above pre-pandemic levels and banks are suffering increasing losses on unpaid consumer debt.  

Business investment growth remains uneven as the cost of capital is elevated, and businesses fret over slowing consumer demand, upcoming elections, and geopolitical concerns. Investment picked up in Q1 2024, but remained skewed towards intellectual property and Q2 investment was mostly fueled by a likely one-off spike in transportation equipment.  The Conference Board Measure of CEO Confidence for Q3 revealed most CEOs of large firms do not anticipate a US recession but are still only cautiously optimistic. Investment plans in the CEO survey were also for the most part unchanged: if cuts were in tow, then they will happen, or if spending is in the future, then it will happen.

Businesses are investing in intellectual property (e.g., digital transformation, AI) and talent, but not in capital equipment and structures apart from factories. Industrial policies encouraging infrastructure improvement and onshoring of supply chains are bolstering manufacturing facility construction and road repairs, but not much investment in other commercial structures. Meanwhile, the collapse of CRE prices, due to the troubled office space market, likely is also weighing on business investment in structures. As such, anemic capex probably will continue over the balance of 2024. However, The Conference Board Measure of CEO Confidence survey revealed that CEOs of large firms do expect that both the economy and their industries will improve over the course of the next six months. This sentiment, along with lower interest rates may support increased investment later in 2025.

As expected, residential investment fell in Q2 2024, but may pick up over the balance of 2024. Despite the need for more housing, high interest rates, elevated materials costs, labor shortages in the construction industry, and sky-high home prices, are weighing on residential investment. However, after the Fed signaled that interest rate cuts may commence as soon as September, mortgage rates have started to fall. Home prices across most of the country are elevated, but lower mortgage rates may entice some buyers and sellers back into the market and support somewhat more housing construction. This modest revival might even start in late Q3 2024.

Government spending was a positive contributor to economic growth in 2023 due to federal non-defense spending associated with infrastructure, R&D, chips, and energy transition preparedness legislation passed in 2021 and 2022. The contribution from government spending was smaller in Q1 2024 but bounced back in Q2 2024. We project that outlays associated with these government policies should continue to support GDP growth this year and next, but with lessening intensity. Still, political volatility relating to budgets, debt, taxes, and outlays could dampen government spending ahead, and possibly even result in the repeal of key aspects of the legislation that boosted real GDP growth over the last few years.

Net exports were a significant drag on real GDP growth in the first half of 2024, while inventories fell in Q1 but then spiked in Q2. Although exports have been positive, imports have been outsized. The negative contribution from external trade may lessen going forward as a somewhat weaker US dollar may boost shipments abroad and weaker domestic demand curbs imports.  Nonetheless, both trade and inventories remain wildcards regarding their respective contributions to GDP as firms continue to struggle to manage stockpiles amid constantly shifting domestic and international demand.

The labor market is cooling, but from after outsized growth that was necessary for restoring employment post-pandemic. Nonfarm payrolls slowed to 114,000 in July after increasing  by 168,000 on average in Q2, 267,000 in Q1 2024, and 251,000 in 2023. The unemployment rate also ticked up to 4.3 percent in July. Still both we and the Fed judge that the labor market remains relatively healthy. The unemployment rate is quite low historically speaking, and as many industries have rehired workers let go during the pandemic, it makes sense that payroll gains need not be exceptionally large. Additionally, labor shortages are continuing to drive hiring in key industries as Baby Boomers retire and front-line and manual worker jobs remain hard to fill. The labor market probably will continue to moderate, but not collapse as large US firms continue to hoard workers and small firms indicate that they plan to continue hire. While these dynamics are keeping many people employed, labor market churn associated with labor shortages continue to keep  wages and benefits elevated – costs many firms are passing onto consumers.

Consumer price inflation resumed cooling in Q2 2024 after stalling in Q1 2024. Initial data for July suggest that the slowing continued at the start of Q3. Still, the Personal Consumption Expenditure (PCE) deflator inflation remains above the Fed’s 2-percent target. Goods inflation is not the problem: nondurable goods inflation (e.g., food, gasoline) continues to rise on a year-over-year basis but is being offset by falling prices for durable goods like motor vehicles, RVs, and furniture. Hence, most inflationary pressures are from services prices. Slowing shelter cost inflation, consistent with past easing in rent and home price inflation as interest rates rose and sapped housing demand, is helping to moderate services price inflation.

However, progress back to the Fed’s inflation target continues to be challenged by supply-side factors and structural changes that are outside of its control. Elevated labor costs from sticky wages amid labor shortages, continue to raise prices for in-person services like restaurants and healthcare. More high-tech cars, some outfitted with AI, are raising the cost of motor vehicle insurance. Repeated and costly natural disasters are prompting insurance companies to raise premiums on home insurance. Financial services costs in general are rising and health care insurance costs continue to levitate. Some of these pressures are beginning to subside. However, given the tug-of-war between supply- and demand-drivers of inflation, we still project PCE inflation will stabilize at 2 percent by mid-2025.

Given this outlook, the Fed will likely start cutting interest rates in September, and continue cutting each meeting until Q3 2025.  If the Fed reduces rates by 25 basis points per meeting, the fed funds rate would fall by 75 basis points by end-2024 and by another 150 basis points by end-2025 to just above 3 percent. The magnitude of individual actions and the pacing of such could be altered by the realization of either upside or downside risks to the economy. Stubborn inflation, and stronger-than-expected GDP or labor market data might cause the Fed to be more judicious and pause often to assess the effect of its actions. Much cooler inflation and material weakness in growth or labor market might cause the Fed to cut rates in larger increments per meeting.  

Any political pressures to cut interest rates ahead of the upcoming US election in November will have no bearing on the Fed’s decisions, given its independence and focus on monetary policy. However, political events that threaten the economy or cause extreme financial market volatility, including election-related social unrest, federal budget impasses, and/or congressional failure to address the debt ceiling in early 2025, could also affect the timing and extent of interest rate cuts ahead. The Fed might cut rates one or two times and then pause to wait out any turbulence. Indeed, the step-down in monetary policy rates could be protracted and end with higher rates than pre-pandemic averages: the federal funds rate average between the 2008-09 Great Recession and the 2020 pandemic was about 1.5 percent in nominal terms and -0.5 percent in real terms.

Downside risks include geopolitical concerns that might result in spikes in food or energy price inflation, disruptions in critical minerals or semiconductor supply chains, and/or trade wars. Domestic fiscal policy poses risks from uncertainty following the election, a 2025 debt ceiling episode, and the expiry of the Tax Cuts and Jobs Act in 2025. Related to the tax cuts expiry, higher taxes for individuals would reduce consumption and negatively affect companies catering to consumers in the short run. Extending the tax cuts or rendering them permanent would increase federal government deficits and debt over the long run. Additionally, if consumer spending slows too aggressively near-term, companies not suffering from labor shortages may start laying off workers, which might push the US into recession.

On the upside, consumers continue to surprise observers with their elevated levels of spending. Despite the depletion of excess savings and debt accumulation, households may maintain a higher level of consumption than expected. There could also be a surge in housing activity and business investment as the Fed cuts rates. There could also be additional federal government spending to bolster high growth areas of the economy. Such business investment and government spending could bolster productivity. Moreover, advances in technology, especially fuller adoption of existing and future forms of AI might also bolster productivity.