For several quarters now, financial pundits have been praying for a “Goldilocks” fairytale reversal to the nearly two years of tight Federal Reserve (the Fed) monetary policy. The hope was for a “just right” combination of an easing of the stubborn tightness in the labor markets accompanied by declining inflation, without triggering a recession. A weak jobs report in the initial month of the third quarter scared many into thinking the landing might be “too hard,” resulting in a sharp sell-off in equities, especially those of the high-flying tech stocks in the ‘magnificent seven.’ However, markets rebounded before reaching new highs, based on the expectation that the Fed would now have room to deliver a long-awaited easing in shortterm lending rates. And deliver they did. At the September FOMC meeting, the Fed cut overnight lending rates by 0.5%, a magnitude most often reserved to fend off deep recessions or crises. In fact, during the last 50 years, the Fed has only cut rates by 50 basis points or more on four other occasions: in 1998 to confront the collapse of the Indonesia Rupia, which sparked a global currency crisis, 2001’s response to 9-11, in 2008, to combat the onslaught of the Great Financial Crisis, and most recently in 2020, in response to COVID-19. Did a disappointing jobs report that occurred during a still-strong labor market warrant such a large cut? Had the Fed truly tamed inflation? Was the economy honestly at risk of rolling over into a recession, let alone a deep recession (despite Q3’s initial estimate for real GDP coming in at a 2.8% growth rate)? A weak October jobs report gave some support for this aggressive move from the Fed, and they followed up with another 15 0.25% cut in in early November. But that jobs report was impact by not one, but two massive hurricanes hitting during the month. We must remember that there were three bears in the Goldilocks story. If the Fed was premature in cutting rates so drastically, Goldilocks may not find the soft economic landing that is “just right,” if we find a landing at all! If inflation reaccelerates, those bears may take center stage in the next act of the play.
How the Markets Faired With the Fed in easing mode, the entire yield curve shifted lower. The 10-year Treasury saw yields drop over a half percent from 4.34% to end Q2 to 3.80% at Q3’s quarter close. This helped propel returns of over 5% across most intermediate and long dated bonds for the quarter. The longer a bond’s duration, the larger the gains. This was even more true for fixed income in developed markets. Returns were still positive but more musted for emerging markets bonds.
Most global equity markets saw significant gains after recovering from the short-lived correction in August. The third quarter saw value indices in both large cap domestic and developed market international, as well as those of mid and small cap stocks assume market leadership as many investors rotated out of high-valuation large-growth stocks into most areas of equity diversification. With the exception of those highly appreciated big tech names, most equity indices posted nearly 10% gains. Latin American emerging markets were another area of sluggishness. This may have been due in part to little change in the commodity prices that impact these economies, which are so heavily reliant on the export of natural resources.
ConZOOMers! Consumer confidence is growing more and more optimistic. The Conference Board’s Consumer Confidence Index jumped to 108.7 in October, up from 99.2 in September. This boost is a bit surprising as we still face the unknown results of the U.S. presidential election. The gains occurred across the board, led by a large spike in the present situation index. The University of Michigan Consumer Sentiment index was up marginally from the prior month at 70.5, but that report lags the Conference Board report by over two weeks.
If retail sales are any indicator, consumers will stay optimistic and active going into the key holiday season. Retail sales for September were up 0.4% month-over-month, with big increases in discretionary spending on things like clothing and dining (and drinking) out. The first estimate of third quarter GDP showed that Personal Consumption Expenditures (PCE) increased 3.7% during the quarter. If the Fed was looking for American households to slow down their demand for goods and services, they may be disappointed.
Inflation Reanimation There are initial signs that the deceleration in inflation may be taking a pause at best and reversing itself in the worst-case scenario. Consumers are seeing increases in Core CPI (ex-food and energy) for September of 0.2% month-over-month, growing to a 3.3% increase year-over-year. At the wholesale level, the Producer Price Index (ex. food and energy) increased by 0.2% in September, for an annual increase of 2.8% over last year. That may still be under the 3% mark, but it also represented an increase of last month’s 2.6% annual rate. With the Fed targeting long-term inflation of 2%, any reversal of the downward trend creates a headwind for the Fed to lower interest rates further. The Fed has indicated that it pays closer attention to Personal Consumption Expenditures (“PCE”) as an indicator of true inflation. The core PCE Price Index, which excludes food and energy, released on 10/31/24, was up 0.3%, which was up 2.7% year-over-year for the third consecutive month. Again, this was below the 3% level but is not showing further signs of easing as the Fed might wish.
In addition to the cost of goods, investors should pay close attention to the increasingly important cost of services in the U.S. Despite not making most of the headlines for PCE or the more traditional measures of inflation, CPI and PPI, services have become a significant part of household budgets. The latest PCE, for services for the month of September, was up 3.7% year-over-year. The CPI Services index confirms the PCE data, showing an increase of 4.7% year-over-year. (As a point of reference, that index routinely hovered in the 2%–3% range prior to COVID-19.)
Is There a Draft in the House? It’s Getting a Little Chilly
The housing market may be seeing its first real sign of cooling. After peaking in June at $426,900, median existing-home prices for September declined to $404,500. That’s still up about 3% from last September but clearly well off the summer highs. Though lagging by a month, the August Case-Shiller Index is confirming that price appreciations have started to plateau, showing just a 4.2% year-over-year growth in prices.
One would expect the buyers to take advantage of the nearly one-percent drop in mortgage rates last quarter (and they are) but not nearly enough to support falling median prices. Adding to the ebbing trend is growing unsold inventory, which stands presently at a 4.3-month supply, up from 4.2 months in August and 3.4 months last September. This is still well below the approximately 6 months supply level that is generally assumed to be equilibrium, but at the very least, the sellers’ market appears to be drawing to a close, at least for now.
Labor Wanes? The Fed used the slack in the non-farm payroll reports for August (reported adding 159,000 jobs) and July (adding 144,00 jobs) as ammunition to cut short-term interest rates. However, job growth rebounded in September back to a solid increase of 254,000. However, October saw job growth grind to a halt, adding just 12,000 jobs. At first glance, one may think that this number was potentially influenced by Hurricane Helene and Hurricane Milton, and it likely was to a point. However, the October report also carried with it downward revisions to the September and August numbers, of 32,000 and 81,0000, respectively. Though the unemployment rate remains at a low 4.1%, the recent trend shows that the tightness in the labor market has eased, at least for the time being.
Unfilled jobs in the U.S. still remain at an elevated level of 7.4 million, but that number has declined significantly after peaking above 12 million at the beginning of 2022. North Pier has estimated that declining below 6.5 million may be an indicator that the job market has finally reached equilibrium. We aren’t quite at that level yet, but we can see it from here. If the force multiplier of AI continues to accelerate, the labor markets may begin to see slack, which would impact the consumer, the housing market, the equity markets, and the economy as a whole. Alternatively, with a consequential election looming, some employers may be delaying hiring plans until after the results of the election are known. We will likely know whether the labor market continues to cool or reignites within the next three months
Broad strength in the labor market and the resulting wage growth have been key contributors to inflation for the last two years. The average American worker has seen their earnings increase by over four percent, year-over-year, for over two years now. (October’s BLS report showed 4% year-over-year average hourly wage growth.) This is due in part to the still tight labor market, which spent nearly three years at sub-4% unemployment. Even at its current level, the unemployment rate suggests that workers still have the upper hand. But for how long?
Risky Business The latest Institute of Supply Management® (ISM®) Report On Business (ROB)® Manufacturing Index declined to 46.5%, down from 47.2% in September. The headline survey results confirm that the manufacturing sector in the U.S. remains anemic. However, there were signs that the data may have been temporarily depressed, likely due to the successive hurricanes that hit the southeast last month. The production portion of the index declined to 46.2% from 49.8%, yet new orders actually rose a bit to 47.1% from 46.1% last month. Once data normalizes next month, we may see a slightly better trend in manufacturing. The October ISM Purchasing Managers Services Index (PMI)® for October showed substantial strength, rising to 56.0% from 54.9% last month, indicating increasing positive conditions in the services side of the economy. With services representing nearly two-thirds of the private sector, this strength is encouraging. However, as we noted above, we are also seeing inflationary pressure in the services end of the economy, so that strength in activity may also be a challenge to abating inflation from that perspective.
Piering Ahead Last quarter, we cited Fed Chairman Powell’s qualifying remarks back in August, “[T]he timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.” Fast forward two months and the “incoming data” has exhibited a resilient consumer, momentum in strong GDP growth, and inflation that is anything but tamed. However, the risk of a slowdown is increasing as tight labor markets and housing markets continue to ease. With a new Administration coming in that’s know for deregulation, however, the economy could heat back up, if not overheat, awfully fast. Labor reports may have only been depressed as HR leaders put new hires on hold awaiting election results. (This has happened routinely prior to contentious elections in the past.) Still further, nearly half of the voting population is disappointed with the election results, which could dampen consumer behavior, creating headwinds in the short-term for that end of the economy, Another result from the election may be austerity at the Federal level. With Elon Musk at his side, President Elect Trump has pledged to cut the fat in Washington, which could create slack in the same labor market, even if things are heating up in the private sector. The potential for higher inflation (which still remains untamed), while simultaneously experiencing a more challenging economy is still on the table. However, it seems that the market desires, if not outright expects, the opposite to happen: lower rates and a strong economy. With uncertainty about the direction and effectiveness of the incoming administration’s initiatives, we continue to caution against assuming any outcome until the fog of election results and economic data clears. After the aggressive 50 basis point rate cut earlier in September, Chairman Powell spoke at the National Association for Business Economics Annual Meeting in Nashville. He once again hedged his comments by concluding,
“[W]e are not on any preset course. The risks are two-sided, and we will continue to make our decisions meeting by meeting. As we consider additional policy adjustments, we will carefully assess incoming data, the evolving outlook, and the balance of risks.”
The incoming data has largely been unfriendly for more aggressive rate cuts, the outlook has clouded, and the balance of risks has, in fact, “balanced” to indicate both a chance of sustained or growing inflation and potential economic slowing. Without any pre-election political motivations (if any existed), the December FOMC meeting may be a disappointment for those looking for deeper cuts. The Fed has a challenging job ahead of it. To get both the direction and timing of Fed policy “just right” to land the Goldilocks soft landing everyone hopes for will require nothing short of PIERfection.
Fall 24 Market & Economic Commentary:
For several quarters now, financial pundits have been praying for a “Goldilocks” fairytale reversal to the nearly two years of tight Federal Reserve (the Fed) monetary policy. The hope was for a “just right” combination of an easing of the stubborn tightness in the labor markets accompanied by declining inflation, without triggering a recession. A weak jobs report in the initial month of the third quarter scared many into thinking the landing might be “too hard,” resulting in a sharp sell-off in equities, especially those of the high-flying tech stocks in the ‘magnificent seven.’ However, markets rebounded before reaching new highs, based on the expectation that the Fed would now have room to deliver a long-awaited easing in shortterm lending rates.
And deliver they did. At the September FOMC meeting, the Fed cut overnight lending rates by 0.5%, a magnitude most often reserved to fend off deep recessions or crises. In fact, during the last 50 years, the Fed has only cut rates by 50 basis points or more on four other occasions: in 1998 to confront the collapse of the Indonesia Rupia, which sparked a global currency crisis, 2001’s response to 9-11, in 2008, to combat the onslaught of the Great Financial Crisis, and most recently in 2020, in response to COVID-19. Did a disappointing jobs report that occurred during a still-strong labor market warrant such a large cut? Had the Fed truly tamed inflation? Was the economy honestly at risk of rolling over into a recession, let alone a deep recession (despite Q3’s initial estimate for real GDP coming in at a 2.8% growth rate)? A weak October jobs report gave some support for this aggressive move from the Fed, and they followed up with another 15 0.25% cut in in early November. But that jobs report was impact by not one, but two massive hurricanes hitting during the month. We must remember that there were three bears in the Goldilocks story. If the Fed was premature in cutting rates so drastically, Goldilocks may not find the soft economic landing that is “just right,” if we find a landing at all! If inflation reaccelerates, those bears may take center stage in the next act of the play.
How the Markets Faired
With the Fed in easing mode, the entire yield curve shifted lower. The 10-year Treasury saw yields drop over a half percent from 4.34% to end Q2 to 3.80% at Q3’s quarter close.
This helped propel returns of over 5% across most intermediate and long dated bonds for the quarter. The longer a bond’s duration, the larger the gains. This was even more true
for fixed income in developed markets. Returns were still positive but more musted for emerging markets bonds.
Most global equity markets saw significant gains after recovering from the short-lived correction in August. The third quarter
saw value indices in both large cap domestic and developed market international, as well as those of mid and small cap
stocks assume market leadership as many investors rotated out of high-valuation large-growth stocks into most areas of
equity diversification. With the exception of those highly appreciated big tech names, most equity indices posted nearly
10% gains. Latin American emerging markets were another area of sluggishness. This may have been due in part to little
change in the commodity prices that impact these economies, which are so heavily reliant on the export of natural
resources.
ConZOOMers!
Consumer confidence is growing more and more optimistic. The Conference Board’s Consumer Confidence Index jumped
to 108.7 in October, up from 99.2 in September. This boost is a bit surprising as we still face the unknown results of the
U.S. presidential election. The gains occurred across the board, led by a large spike in the present situation index. The
University of Michigan Consumer Sentiment index was up marginally from the prior month at 70.5, but that report lags the
Conference Board report by over two weeks.
If retail sales are any indicator, consumers will stay optimistic and active going into the key holiday season. Retail sales for
September were up 0.4% month-over-month, with big increases in discretionary spending on things like clothing and
dining (and drinking) out. The first estimate of third quarter GDP showed that Personal Consumption Expenditures (PCE) increased 3.7% during the quarter. If the Fed was looking for American households to slow down their demand for goods
and services, they may be disappointed.
Inflation Reanimation
There are initial signs that the deceleration in inflation may be taking a pause at best and reversing itself in the worst-case
scenario. Consumers are seeing increases in Core CPI (ex-food and energy) for September of 0.2% month-over-month,
growing to a 3.3% increase year-over-year. At the wholesale level, the Producer Price Index (ex. food and energy)
increased by 0.2% in September, for an annual increase of 2.8% over last year. That may still be under the 3% mark, but it
also represented an increase of last month’s 2.6% annual rate. With the Fed targeting long-term inflation of 2%, any
reversal of the downward trend creates a headwind for the Fed to lower interest rates further. The Fed has indicated that it
pays closer attention to Personal Consumption Expenditures (“PCE”) as an indicator of true inflation. The core PCE Price
Index, which excludes food and energy, released on 10/31/24, was up 0.3%, which was up 2.7% year-over-year for the
third consecutive month. Again, this was below the 3% level but is not showing further signs of easing as the Fed might
wish.
In addition to the cost of goods, investors should pay close attention to the increasingly important cost of services in the
U.S. Despite not making most of the headlines for PCE or the more traditional measures of inflation, CPI and PPI, services
have become a significant part of household budgets. The latest PCE, for services for the month of September, was up
3.7% year-over-year. The CPI Services index confirms the PCE data, showing an increase of 4.7% year-over-year. (As a
point of reference, that index routinely hovered in the 2%–3% range prior to COVID-19.)
Is There a Draft in the House? It’s Getting a Little Chilly
The housing market may be seeing its first real
sign of cooling. After peaking in June at $426,900,
median existing-home prices for September
declined to $404,500. That’s still up about 3% from
last September but clearly well off the summer
highs. Though lagging by a month, the August
Case-Shiller Index is confirming that price
appreciations have started to plateau, showing just
a 4.2% year-over-year growth in prices.
One would expect the buyers to take advantage of the nearly one-percent drop in mortgage rates last quarter (and they are) but not nearly enough to support falling median prices. Adding to the ebbing trend is growing unsold inventory, which stands presently at a 4.3-month supply, up from 4.2 months
in August and 3.4 months last September. This is still well below the approximately 6 months supply level that is generally
assumed to be equilibrium, but at the very least, the sellers’ market appears to be drawing to a close, at least for now.
Labor Wanes?
The Fed used the slack in the non-farm payroll reports for August (reported adding 159,000 jobs) and July (adding 144,00
jobs) as ammunition to cut short-term interest rates. However, job growth rebounded in September back to a solid increase
of 254,000. However, October saw job growth grind to a halt, adding just 12,000 jobs. At first glance, one may think that this
number was potentially influenced by Hurricane Helene and Hurricane Milton, and it likely was to a point. However, the
October report also carried with it downward revisions to the September and August numbers, of 32,000 and 81,0000,
respectively. Though the unemployment rate remains at a low 4.1%, the recent trend shows that the tightness in the labor
market has eased, at least for the time being.
Unfilled jobs in the U.S. still remain at an elevated level of 7.4 million, but that number has declined significantly after
peaking above 12 million at the beginning of 2022. North Pier has estimated that declining below 6.5 million may be an
indicator that the job market has finally reached equilibrium. We aren’t quite at that level yet, but we can see it from here. If
the force multiplier of AI continues to accelerate, the labor markets may begin to see slack, which would impact the consumer, the housing market, the equity markets, and the economy as a whole. Alternatively, with a consequential election looming, some employers may be delaying hiring plans until after the results of the election are known. We will likely know whether the labor market continues to cool or reignites within the next three months
Broad strength in the labor market and the resulting wage growth have been key contributors to inflation for the last two
years. The average American worker has seen their earnings increase by over four percent, year-over-year, for over two
years now. (October’s BLS report showed 4% year-over-year average hourly wage growth.) This is due in part to the still
tight labor market, which spent nearly three years at sub-4% unemployment. Even at its current level, the unemployment
rate suggests that workers still have the upper hand. But for how long?
Risky Business
The latest Institute of Supply Management® (ISM®) Report On Business (ROB)® Manufacturing Index declined to 46.5%,
down from 47.2% in September. The headline survey results confirm that the manufacturing sector in the U.S. remains
anemic. However, there were signs that the data may have been temporarily depressed, likely due to the successive
hurricanes that hit the southeast last month. The production portion of the index declined to 46.2% from 49.8%, yet new orders actually rose a bit to 47.1% from 46.1% last month. Once data normalizes next month, we may see a slightly better
trend in manufacturing. The October ISM Purchasing Managers Services Index (PMI)® for October showed substantial
strength, rising to 56.0% from 54.9% last month, indicating increasing positive conditions in the services side of the
economy. With services representing nearly two-thirds of the private sector, this strength is encouraging. However, as we
noted above, we are also seeing inflationary pressure in the services end of the economy, so that strength in activity may
also be a challenge to abating inflation from that perspective.
Piering Ahead
Last quarter, we cited Fed Chairman Powell’s qualifying remarks back in August, “[T]he timing and pace of rate cuts will
depend on incoming data, the evolving outlook and the balance of risks.” Fast forward two months and the “incoming data”
has exhibited a resilient consumer, momentum in strong GDP growth, and inflation that is anything but tamed. However, the
risk of a slowdown is increasing as tight labor markets and housing markets continue to ease.
With a new Administration coming in that’s know for deregulation, however, the economy could heat back up, if not
overheat, awfully fast. Labor reports may have only been depressed as HR leaders put new hires on hold awaiting election
results. (This has happened routinely prior to contentious elections in the past.) Still further, nearly half of the voting
population is disappointed with the election results, which could dampen consumer behavior, creating headwinds in the
short-term for that end of the economy, Another result from the election may be austerity at the Federal level. With Elon
Musk at his side, President Elect Trump has pledged to cut the fat in Washington, which could create slack in the same
labor market, even if things are heating up in the private sector. The potential for higher inflation (which still remains
untamed), while simultaneously experiencing a more challenging economy is still on the table. However, it seems that the
market desires, if not outright expects, the opposite to happen: lower rates and a strong economy. With uncertainty about
the direction and effectiveness of the incoming administration’s initiatives, we continue to caution against assuming any
outcome until the fog of election results and economic data clears.
After the aggressive 50 basis point rate cut earlier in September, Chairman Powell spoke at the National Association for
Business Economics Annual Meeting in Nashville. He once again hedged his comments by concluding,
“[W]e are not on any preset course. The risks are two-sided, and we will continue to
make our decisions meeting by meeting. As we consider additional policy
adjustments, we will carefully assess incoming data, the evolving outlook, and the
balance of risks.”
The incoming data has largely been unfriendly for more aggressive rate cuts, the outlook has clouded, and the balance of
risks has, in fact, “balanced” to indicate both a chance of sustained or growing inflation and potential economic slowing.
Without any pre-election political motivations (if any existed), the December FOMC meeting may be a disappointment for
those looking for deeper cuts. The Fed has a challenging job ahead of it. To get both the direction and timing of Fed policy
“just right” to land the Goldilocks soft landing everyone hopes for will require nothing short of PIERfection.
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