As expected, the Federal Reserve (Fed) once again held the benchmark rate steady at 5.25%–5.50% at its October-end Federal Open Market Committee (FOMC) meeting. As has become the norm at these meetings, the press used just about every question they were given to coax a hint out of Chair Powell on what is to come at the next meeting. He made it clear that the FOMC did not speak about the December meeting and that their main question of focus right now is “should we hike more?” Powell went on to explain that the second consecutive pause was ultimately determined “because slowing down is giving us a better sense of how much more we need to do, if we need to do more.” Powell went on to give mostly predictable answers to the press, but there were select moments where he seemed to move off script.

QUESTION: Chair Powell, are you as concerned about overshooting on rates as you are about inflation not reaching your 2% goal?

Powell explained that the risks of overtightening and not tightening enough are getting closer to “being in balance.” The Fed ultimately wants to be sure inflation is continuing to broadly cool. As we will explain further, wage growth is slowing and the supply and demand dynamics in the labor force are inching closer to equilibrium. While this is progress the Fed wants to see continue, they seem less rushed as to the speed it happens. As they have noted many times, they are proceeding carefully due to the inherent lags monetary tightening entails.

QUESTION: Chair Powell, did the recent rise in long-term yields at all affect this decision to pause?

Ultimately, Powell responded in an affirmative manner. After all, higher 10-year yields have an impact on financial conditions and thus, future monetary policy decisions. However, Powell noted that it does not appear expectations of higher rates have been playing a role in driving those elevated long-term yields. He emphasized that, from a broader perspective, these conditions would need to persist for them to have a real effect on future policy decisions. Powell went on to hint that the ongoing quantitative tightening the Fed began last year may have had a small impact on the move in the 10-year rate.

All in all, it was an unsurprising FOMC meeting. It seems the hurdle for further rate hikes has risen and the Fed no longer feels rushed to tighten further as long as they are seeing inflation progress to their 2% goal. While we expect the Fed to leave rates unchanged in December, it will ultimately depend on the data to come. 

Time for the usual check-up…

Economy

The third quarter GDP reading was released on the 26th, coming in at a 4.9% annualized rate, which was well above the median economists’ estimate of 3.8%, but not so far off of the Atlanta Fed’s GDPNow prediction coming into the release. The price deflator component of the report, which measures changes in prices for all goods and services, rose 3.5% compared to the 2.9% estimate and the 1.7% increase in the second quarter, further driving concern that the strong economic growth could keep inflation higher and thus force the Fed to continue with their tightening cycle. Consumers were the drivers of the outsized growth rate as personal consumption rose 4.0%, contributing 2.7 points to the GDP growth. Change in nonfarm inventories contributed 1.3 points to the third quarter GDP, which could be a leading indicator of inventory destocking to come – an inherent negative on future GDP growth. Government spending contributed 0.8 points to the third quarter GDP reading, which could be expected to continue into 2024 given the rising geopolitical risks and resulting defense spending. Unsurprisingly, investment spending was flat given the growing concern among the business community over the sustainability of the expansion.

The September personal income and spending report also came in just before the FOMC meeting. Personal income grew at 0.3%, which was a slight miss of the 0.4% estimate and a slowdown of the 0.4% August reading. Personal spending grew at 0.7%, which was faster than the 0.5% survey and almost double the 0.4% rate in August. Given the faster spending rate, savings as a percentage of disposable income dropped to 3.4% from the 4.0% ratio in August – the lowest it has been since the end of 2022. So, while the jobs market has looked so far resilient, it begs the question if the consumer is running low on fuel to drive further spending growth.

Consumer sentiment appears to be growing more hesitant entering the fourth quarter. The final October University of Michigan Sentiment indicator came in at 63.8, which was notably lower than the 67.9 recorded in September. Higher energy prices in September appear to have sapped confidence leading to higher inflation expectations. However, energy prices declined in October with the higher crude prices not having the same impact on refined gasoline and heating oil.

Durable goods orders were up 4.7% for the month of September, which was well above both the 1.5% estimate and the flat reading in August. Core durables, which remove lumpy defense and aircraft orders, were up +0.6% – well above the -0.3% consensus. So, while business spending may be slowing, it seems purchasing and supply managers are more confident on the near term.

As of the 27th, with 49% of the S&P 500 reporting, 78% have reported positive earnings surprises and 62% have reported positive revenue surprises. The third quarter year-over-year growth rate stands at 2.7% thus far, which is the first quarter of year-over-year growth for the index since the third quarter of 2022. Of course, that data could change with more companies to report earnings in the coming weeks.

Inflation

September CPI was released earlier last month, coming in at +0.4% on the headline, which was hotter than the +0.3% estimate. Core CPI, which excludes food and energy, was up 0.3% for the month, which was in line with estimates. Shelter lead the way in core inflation, rising +0.6% as hotel prices began reversing course and heading north. “Supercore” inflation which strips out shelter from services prices, picked up steam in September, rising +0.61% on a monthly basis – it’s largest gain in a year. The annual rate, however, dipped 9 basis points to 3.91%. While the CPI report was largely in line with expectations, continued stickiness in services ex-housing could further reduce the chances of rate cuts next year should the economy remain resilient. The October CPI reading will come out on November 14th and should help us gauge what to expect from the Fed for the remainder of this year.

Also released last month were the September producer price indices (PPI). While PPI came in hotter than expected, price inflation at this intermediate level is closer to the Fed’s 2.0% target with headline inflation at 2.2% and core at 2.7%. Of note were energy and food prices – up 3.3% and 0.9%, respectively, which both rose at their fastest rates since November of 2022.

Late last month, September PCE data was released. Core prices (excluding food  and energy) increased 0.3%, in line with estimates, but higher than the +0.1% in August. The year-over-year core reading declined slightly to 3.7% from 3.8% in August. Should this disinflation progress, it could be enough to prevent further tightening.

As mentioned in our previous note, the United Auto Worker (UAW) strike would be a key concern in the short term. Looking at recent wage settlements between the UAW and major auto manufacturers, Ford and Stellantis, these concerns were validated with tentative agreements outlining 25% compounded wage increases that the inflation-concerned investment world viewed as generous. Alas, one concern dissipates, and another takes its place with the tragedies in the Middle East spurring oil prices. While oil prices have come off their peaks as of late, further expansion of the Middle East conflict could drive oil back higher, which would ultimately motivate further inflation.

Job Market

As we noted, labor and wages remain the primary drivers of consumer spending. Weekly jobless claims are still historically low with the week ending October 28th reading coming in at 217k. However, both labor force participation and immigration have picked up since the end of 2022, feeding more supply into the labor market. As a result, wage growth has come down, with ADP’s October private payroll data showing an 8.4% gain – the slowest pace since July 2021.

October nonfarm payrolls rose softer than expected at 150k versus the 180k consensus. The United Auto Workers strikes were primarily responsible for the gap as the impasse drove a net loss of 33,000 jobs for the manufacturing industry. Leisure and hospitality, which has been a leading sector for job gains, came in at a softer 19,000. Along with the payrolls release, came average hourly earnings, which rose 0.2% month over month – below the 0.3% expectation. The October unemployment rate rose to 3.9%, which was 10 basis points higher than economists’ estimates. The underemployment rate, which includes discouraged and part-time workers rose 20 basis points to 7.2%, implying much of the hiring that occurred over the summer is now cooling. The decelerating job creation and wage growth should take pressure off the Fed, leaving them room to continue their “pause” in this so-far historic tightening cycle. Regardless, as pandemic effects on inflation become a lapping memory, the shifting dynamics of the labor market will come center stage at every Fed meeting going forward.

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