This week a litany of economic data will be released with the latest reading of the Personal Consumption Expenditures (PCE) index, also known as one of the Fed's preferred inflation gauge, will be released on Friday. With the debate over what the next policy decision from the Federal Reserve could look like raging on, many on Wall Street will watch closely for the results of the reading.
Chief Economist Allianz Ludovic Subran joins The Morning Brief to give insight into what the upcoming PCE data could tell investors about the next policy decision from the Fed.
On the upcoming PCE data, Subran states: "If we get another PCE above 3.5 or 4% the problem is we are going to have to delay the Fed's first rate cut after the summer. Then you have elections, you guys have elections in November. So the problem is it's a catch-22, right? Can the Fed start cutting in September and then pause and then cut again in December to deliver 50 bps which is what the market expects? Or do they cut two days after the election results?"
He continues with his expectations: "We expect to cut in September but it's true that is quite far already and the benefits will be only visible in 2025, so it's a very political loosening cycle that is ahead of us, especially candidate Trump is promising to reheat a bit, the US economy if he gets elected, so the Fed could actually be forced to stop halfway through the loosening cycle and have a very bizarre 2025."
- Big week for econ data. Investors will be getting a closer look at housing, economic growth, and inflation, including the Fed's preferred inflation gauge PCE. That's going to be released on Friday. To break it all down, we want to bring in Ludovic Subran, Allianz chief economist is here. Ludovic, it's great to see you. So talk to us just about the importance of the econ data that we have on tap this week. And what kind of insight this potentially is expected to give on the Fed's timing of the first rate cut?
LUDOVIC SUBRAN: Look, it's a very important crossroads, right, because everybody is looking at the Fed, including us over here in Europe, because we wouldn't want to start cutting rates before the Fed commits to it. So, of course, we're going to watch, you know, whether the PCE can come notoriously down compared to its last reading because that's a key indicator for the Fed. But also, we're going to look at Q1 GDP numbers to understand a bit how much overheating is still in the US economy. And that warrants a form of action from the Fed. So all eyes indeed on the week. I think you just showing the 3.4% revised Q4 annualized data for the US, which was quite a strong read when you think about what was expected by consensus.
- If we get a hotter than expected PCE reading this week, how does that massively change the outlook for the Fed's rate cut pathway this year?
LUDOVIC SUBRAN: Look, if we get another PCE above 3.5% or 4%, the problem is we're going to have to delay the Fed first rate cut after the summer. And then you have elections. You guys have elections in November.
So the problem is it's a catch-22, right. Can the Fed start getting in September? And then pause and then cut again in December to deliver 50 bips, which is what markets expect. Or do they cut two days after the election result?
And I don't think-- I mean, I think you can say that if it's really dependent politically, you could do that. We expect it to cut in September. But it's true that it's quite far, you know, already. And the benefits will be only visible in 2025. So it's a very political loosening cycle that is ahead of us, especially because-- especially candidate Trump is promising to reheat a bit the US economy if he gets elected. So the Fed could actually be forced to stop halfway through the loosening cycle and have a very bizarre 2025 when it comes to the right pathway.
- Would that be a mistake if the Fed doesn't cut before the elections?
LUDOVIC SUBRAN: Ha. I don't think so. I think-- personally, I think the US is ripe for cuts right now. But if they didn't cut before, I think the only problem would be-- I would be very concerned for market reaction, especially you've been talking in your show just before about the equity markets and especially what is expected of big tech. I'm worried about the debt market.
I'm worried about high yield, and I'm worried about all these companies. But also, these households whose mortgage affordability is at stake. So I think the s will be if the first cut is delivered into 2025, we would see very negative reading for growth, especially in Q4 in the US.
- Ludovic, talk to me a little bit more just about that risk that you see brewing within the debt market and exactly what that means for economic growth and then essentially the trickle down effect to why this is also a massive risk here for the markets as well.
LUDOVIC SUBRAN: Look. I believe this cycle is very different mostly because of fiscal policy. The 8% deficit explains, I would say, most of the absence of transmission of monetary policy to especially spreads in the investment grade and high yield segment. I think they are too narrow, to be honest, compared to the firm's financials.
Some firms are actually doing very well and are still loaded with cash, but there is still a huge segment of the market, 20%, 25% I think of the issuance that is at risk that looks very zombified to me. And of course, if the Fed were a bit late to the cut, I think the refinancing world would start kicking in.
So 2025, 20% or so of some of these companies have to refinance their debt. So if they refinance at 5%, or 6%, or 7% instead of refinancing 100 basis points below, of course, that changes completely the game because they are already zombie companies, where net refinancing costs are higher than the EBITDA. So I would be worried about some of them going belly up, yeah.
- OK. There's kind of two prongs as well here that we also have to consider for the Fed. And the other side of this is employment, where do you think employment continues to trend and the labor market more broadly as we've seen some hotter than expected prints and then revisions kind of balance things out on aggregate. But at the same time, there's still the wage pressure consideration that could flow through directly to the inflation picture.
LUDOVIC SUBRAN: I think the labor market is to be frozen for the next six months because firms are going to wait and see mode. So there was a front loading of the so-called IRA subsidies that were supposed to come. By the way, they didn't come as much as most firms were expecting. So that was a bridge, and that caused a lot of labor hoarding.
Now, there is still good consumer data. So I think if the services, the leisure industry, hospitality, et cetera, the jobs numbers are good. But I'm expecting jobs numbers to cool down significantly into H2. And, of course, that would be also one of the trigger, I would say, or the confidence measures that the Fed will use to start the loosening cycle.
The question here is mostly the terminal rate, right. Can the Fed deliver 150 basis points by the end of 2025? I'm not sure that it can, actually. And that's the big question. Because this is what it needs to cool down the debt market that I just mentioned.
