Liquid Assets Are Back To Pre-Covid Levels. Markets Are Pricing For Dovish Fed.

In the beginning of 2023, expectations for the U.S. economy were much gloomier than what has materialized in the first 11 months of the year. In Bloomberg’s December 2022 economist survey, the median forecast of GDP growth for 2023 was just 0.37%. However, real GDP expanded by 2.4% through the first three quarters of 2023 (not annualized), and current quarter growth is expected to remain in positive territory. The Fed wasn’t much more optimistic entering this year. Its December 2022 Summary of Economic Projections showed a median forecast of 0.5% for real GDP growth in 2023.

This unexpected resilience has come despite multiple obstacles, including bank failures in March, Chinese economic struggles, and geopolitical events. As we have discussed in past commentaries, the stimulus-induced windfall of liquidity for U.S. households created a strong headwind for consumer spending, particularly with the unemployment rate historically low and wage growth historically high. According to Federal Reserve data, household liquid assets, which include bank deposits and money market fund balances, surged in 2020 and 2021, which along with wage growth fueled the better-than-expected consumption over the past year.

Based on the most recent information from the Federal Reserve on household liquidity, after accounting for inflation, all but the top two income brackets are now close to pre-COVID levels in terms of liquid assets. Not surprisingly, the lowest income brackets have suffered the most from higher prices for goods and services. As such, households might take a more defensive posture on spending in 2024.

Financial markets priced for a more dovish Fed in 2024 as November progressed. By month-end, fed funds futures priced an initial rate cut in the second quarter, with roughly 135 basis points of cuts by year-end 2024. That would be an aggressive path for the Fed, and there’s clearly a disconnect with the median economist forecast for GDP growth in 2024 of 1.2% with no negative quarters according to the current Bloomberg survey (i.e., soft landing). If upcoming employment and inflation reports reveal stickier employment and inflation data, the market would need to reprice for a less dovish Fed outlook.

Visit ALM First to read about the latest economic data and overall market trends in the December 2023 Market Commentary.

Jason Haley joined ALM First in 2008 and is the firm’s chief investment officer. He heads ALM First’s Investment Management Group (IMG), which is responsible for leading the investment process and investment theme development. Haley also oversees all capital markets activities, including portfolio management, trading, market research and commentary, and execution of hedging and funding strategies for the firm’s depository clients. He holds an MBA with a concentration in finance and a BBA with a concentration in marketing, both from The University of Mississippi.