Written by Steve Andrews
Slow but Steady
Could the Fed have been right after all? Was inflation transitory? While inflation has behaved like the house party guest who can’t take a hint that it’s time they amble on home, inflation has been persistent (sticky), but trending lower, nonetheless. The headline numbers for September Consumer (CPI) and Producer (PPI) prices were a tad higher than expected as rising energy costs in August and September made their presence felt. That said, core CPI (which excludes food and energy costs) was up 4.1% from a year ago – down from the 4.4% yearly increase in August.
Getting it ‘Just Right’
Market angst over the Fed ratcheted up a notch as economic data suggested that the economy was edging further away from a recession. Through late summer, a “Goldilocks” mood had settled in where investors felt that the economy was neither too hot to force the Fed’s hand to raise rates, nor cold enough to usher in a recession. The minutes of the September FOMC meeting where the Fed left rates unchanged showed that FOMC members felt that one more rate increase was “likely appropriate,” as they acknowledged that inflation is receding. Further progress will be needed to reach their 2.0% inflation target as the economy was holding up better than anticipated.
Job Market Updates
We saw that job openings rebounded to 9.6 million at the end of August after dipping to 8.9 million in July. Job growth was very strong in September, with non-farm payrolls rising 336,000 – double the number expected. While we try not to get too excited (or depressed) over a single month’s data, job growth for July and August were revised higher by a combined 119,000. This was a very strong report. Following the jobs report, the yield on the 10-year Treasury rose to 4.89% - a 16-year high - but has since receded as the crisis in Israel made investors flock to the “safe haven” of US Treasuries.
The (Anticipated) Future of Interest Rates
Still, US interest rates remain the focus – especially long-term rates whose performance could determine the Fed’s monetary policy in the months ahead. The rise in the 10-year Treasury yield was eye-opening and disturbing for investors. Part of the rise can be explained by the sharp rise in supply. When there’s too much supply, prices fall which pushed yield higher. The Treasury Department has stepped up issuance of new Treasury Bills, Notes, and Bonds to finance the huge federal budget deficit to the tune of around $300B, give or take, in both August and September which should continue through year end.
At the same time, the stronger economic performance in Q3 has dusted off the “higher for longer” sentiment, as evidenced by the Fed’s dot-plot projections (a chart where each of the 19 FOMC members plot their individual expectations for the Fed Funds in coming quarters). They reduced the number of expected rate cuts in 2024 from 4 as of last June (a full 1.00% in rates) to 2 in the September projections (just 0.50% in rate cuts).
However, these concerns over the Fed overplaying its hand were tempered somewhat as several members of the FOMC, looking at the rise in long-term rates, suggested the possibility that higher interest rates are doing the Fed’s job for them and may lessen the need for further rate hikes. As investors heard those sentiments, it helped to ease the recent rise in long-term rates – for how long remains to be seen.
Consumer Insights
US consumers, fed by a steady diet of generally bad news in the media, turned a bit gloomier as Halloween approaches according to the University of Michigan’s index of consumer sentiment. In early October, it fell to its lowest level (63) since May. Inflation concerns lowered consumers’ assessments of their own personal finances by about 15% and consumers now expect inflation to run at 3.8% over the next 12 months - up from 3.2% a month ago. However, consumers have a long history of worrying about how things will be six months from now but that has not tempered their urge to shop and spend and, since they drive 70% of our economic growth, as long as this continues, the economy will forge ahead.
Residential Construction Rebound
On the residential front, US builders are working through a record number of homes under construction. While new Housing Starts fell to the lowest annual rate in over a year in August (mainly due to a drop in multi-family starts), permits for new construction rose 6.5%. Despite the highest mortgage rates in 17 years, demand remains strong as new household formations grow and there’s a severe shortage of existing homes for sale since few homeowners are willing to give up their 3% mortgage to move into another home, and see their mortgage rate more than double, unless forced to.
In Conclusion
September and October have a history of giving investors fits, and this year is no exception, but October fits have also ushered in the holiday rallies that have carried the markets higher into the New Year. While past history offers no guarantee of future performance, US economic fundamentals are pretty healthy and the prospects of another 0.25% or 0.50% in Fed rates hikes today should be much less worrisome for investors than they were when rates were near-zero. Once the Fed offers some clues that they are done, the markets should claw back much of what they’ve lost. Despite the markets’ moodiness since the end of July, as of mid-month the Dow is up 1.6%, the S&P 500 up 12.7%, and the NASDAQ is up 28.1% for the year.
The September inflation data (CPI & PPI) offer more evidence that the disinflationary trend remains intact. It’s looking more and more like the Fed’s assertion that the sharp rise in prices would be transitory was more prescient than we gave them credit for. Perhaps the problem was with us who thought that by saying “transitory,” the Fed was talking about months – not years. Whether that was by design or by coincidence, we doubt the Fed will ever clarify.
