Dear Friends,
Last week’s headliner was Jerome Powell and the Federal Reserve (Fed) cutting rates by a half percent on Wednesday, September 18, the first time since the COVID-19 pandemic broke out in 2020. The Fed “pause” ended at 423 days and now stands as the second-longest on record. Now that the 0.25% vs. 0.50% debate has been settled, what matters most is how much Powell and company cut for the entire cycle and how lower rates affect the economy. Find out more about what is driving the markets in this week’s newsletter.
Economy, Geopolitics, and Commodities
1. The Fed Has Significantly Improved the Odds of a Soft Landing
In the past month, something that once seemed impossible suddenly became likely. After four years of upheaval, the U.S. now seems to have low inflation, low unemployment, and solid economic growth. The popular term for this is soft landing. A better word is “normal.” This is what an economy is supposed to look like. Until last Wednesday, one thing still looked abnormal: the Federal Reserve’s interest-rate target, which at 5.25% to 5.5%, was much higher than economic conditions called for.
The Fed has begun to rectify that abnormality with its half-point rate cut. This vastly improves the odds of a soft landing. It might even leave the economy and interest rates looking more normal a year from now than before the pandemic. To be clear, “normal” doesn’t mean idyllic. Some people will be unemployed. Some people’s wages will not keep up with inflation. Prices will rise gradually but won’t go back to where they were before the pandemic. Normal simply means sustainable, without the excesses that lead to either recession or accelerating inflation. A little over a year ago core inflation (which excludes food and energy) was around 4%, double its 2% target. That’s using the Fed’s preferred gauge, the price index of personal-consumption expenditures, or PCE. With unemployment near a 50-year low of 3.5% and 1.5 vacancies for every unemployed worker, the Fed feared it would stay there. The outlook today is for more upward pressure on inflation amid reversing globalization, shrinking labor forces, and the costly transition to net zero carbon emissions. Structurally larger government deficits will add upward pressure to interest rates. Looking out a decade, markets think a neutral interest rate will be 3.25% to 3.5%. As confidence grows that the Fed has stuck the soft landing, long-term rates might rise, until they are above the Fed’s rate target. 1
2. US Consumer Sentiment Rises to Five-Month High on Economy Views
US consumer sentiment continued to rise in late September, reaching a five-month high on more optimism about the economy in the wake of the Federal Reserve’s interest-rate cut. The University of Michigan’s final September sentiment index rose to 70.1 from the 69 preliminary reading released earlier this month. The latest figure issued Friday follows an August index of 67.9. Consumers expect prices to rise at an annual rate of 2.7% over the next year, the lowest since the end of 2020 and down from the 2.8% expected last month. They saw inflation rising 3.1% over the next five to 10 years. The increase in sentiment followed a Sept. 18 decision by Fed policymakers to lower interest rates by a half percentage point as they guard against a deterioration in the job market. Further reductions in borrowing costs are helping to underpin consumers’ outlook on the economy and their personal finances.
Earlier Friday, government figures showed a modest advance in August household spending. While expectations earlier in the month showed some concerns about the labor market, consumers’ views about unemployment improved in latter weeks, the university’s report showed. This reflected in part the Fed’s decision to lower rates. Some 55% of respondents see declining borrowing costs in the coming year, the largest share on record. That’s leading to improving views of buying conditions for big-ticket items and homes, which were the most upbeat since April. Consumer sentiment among Democrats rose in September to a five-month high, while it also edged up among Republicans and political independents. The university’s current conditions gauge rose to a three-month high of 63.3, while the expectations index increased to the highest level since April. Consumers’ outlooks for their financial situations climbed to a four-month high in September. Their views of the economy over the coming year were the most upbeat since March.2
3. Key Fed Inflation Gauge at 2.2% in August, Lower Than Expected
Inflation moved closer to the Federal Reserve’s target in August, easing the way for future interest rate cuts, the Commerce Department reported Friday. The personal consumption expenditures price index, a gauge the Fed focuses on to measure the cost of goods and services in the U.S. economy, rose 0.1% for the month, putting the 12-month inflation rate at 2.2%, down from 2.5% in July and the lowest since February 2021. Economists surveyed by Dow Jones had been expecting all-items PCE to rise 0.1% on the month and 2.3% from a year ago.
Excluding food and energy, core PCE rose 0.1% in August and was up 2.7% from a year ago, the 12-month number 0.1 percentage point higher than July. Fed officials tend to focus more on core as a better measure of long-run trends. The respective forecasts were for 0.2% and 2.7% on core. Stock market futures were positive following the report while Treasury yields were negative. The readings come a little more than a week after the Fed took down its benchmark overnight borrowing rate by half a percentage point to a target range of 4.75%-5%. The progress in August came despite continued pressure from housing-related costs, which increased 0.5% on the month for the largest move since January. Services prices overall rose 0.2% while goods declined by 0.2%. In recent days, Fed officials have switched their focus from inflation fighting to an emphasis on supporting a labor market that has shown some signs of softening. At their meeting last week, policymakers indicated a likelihood of another half percentage point in cuts this year then a full point in reductions for 2025, though markets expect a more aggressive path.3
4. China Vows ‘Necessary Spending’ To Hit Economic Growth Target
Chinese leaders pledged on Thursday to deploy “necessary fiscal spending” to meet this year’s economic growth target of roughly 5%, acknowledging new problems and raising market expectations for fresh stimulus on top of measures announced this week. The remarks, which included guidance to the government to support household consumption and stabilize the troubled real estate market, came in an official readout of a monthly meeting of top Communist Party officials, the Politburo. The September meeting is not usually a forum for macroeconomic discussions, which suggests growing anxiety over slowing growth momentum. The world’s second-largest economy faces strong deflationary pressures due to a sharp property market downturn and frail consumer confidence, which has exposed its over-reliance on exports in an increasingly tense global trade environment. A wide range of economic data in recent months has missed forecasts, raising concerns among economists that the growth target was at risk and that a longer-term structural slowdown could be in play.
China’s central bank on Tuesday unveiled its most aggressive monetary easing since the pandemic, flagging cuts to a broad range of interest rates and a 1 trillion yuan ($140 billion) liquidity injection into the financial system, among other steps. Beijing is considering pumping up to 1 trillion yuan into its biggest state banks to increase their capacity to support the struggling economy, primarily by issuing new special sovereign bonds. The Politburo said the government should “promote the stabilization of the real estate market”, expand a whitelist of housing projects that can receive further financing and revitalize idle land, according to the readout.4
5. Eurozone Sentiment Weakens Amid Darker Industry Mood
Economic confidence ebbed in the eurozone this month, dragged lower by worsening sentiment in industry. An aggregate measure of business and consumer confidence for the 20 nations that share the euro fell to 96.2 in September, compared with 96.5 in August. That was weaker than forecast by economists, who had expected a 96.5 reading, according to a poll compiled by The Wall Street Journal.
Published Friday by the European Commission, the surveys showed a grimmer mood in eurozone industry, with the index falling further into negative territory. Households, by contrast, felt a little less pessimistic, and the services industry also booked slightly improving sentiment. It comes on the heels of separate business surveys that this week pointed to a slump in activity in the eurozone, sliding from the bump offered by the Olympic Games held in Paris over the summer. That will likely add fuel to calls for the European Central Bank to more quickly reduce interest rates and ease the burden on investment and demand in the currency union.1
Financial Markets
1. Dow Jumps 100 Points to Close at a Record, Major Averages Extend Rally to Third Week
The Dow Jones Industrial Average climbed to a fresh record on Friday as traders digested new data that pointed to further progress in lowering inflation. Wall Street was also headed for solid weekly gains. The 30-stock Dow added 186 points, or 0.4%. The S&P 500 ticked down 0.008%, while the Nasdaq Composite lost 0.4%. The technology-heavy index’s gains were kept in check by a 4% decline in Nvidia. The three major indexes are higher for the week, with the S&P 500 up nearly 1% and the Dow on pace to rise 0.7%. The Nasdaq is on track for a roughly 1% week-to-date advance. Ten-year Treasury yields edged lower, with the 10-year yield settling at 3.751%. Gold kept climbing this week to $2,644.30 a troy ounce. The metal is on track for its largest one-quarter net gain on record, according to Dow Jones Market Data. The dollar weakened. The greenback traded near its lowest value against a basket of currencies since July 2023. Oil prices edged higher, with benchmark U.S. crude trading at $68.18 a barrel, after a sharp turn lower in recent days.
Traders received encouraging inflation data that could give the central bank more reason to confidently cut interest rates further. August’s personal consumption expenditures price index — the Federal Reserve’s favored measure of inflation — increased 0.1%, matching expectations from economists polled by Dow Jones. PCE increased 2.2% at an annualized pace, below the 2.3% forecast. Policymakers and investors alike are hoping for persistent cooling in monthly inflation figures, allowing for continued easing of borrowing costs that will ease the strain on corporate and household balance sheets.3
2. Costco Sees Discount-Hungry Shoppers Driving Strong Holiday Sales
Costco Wholesale Corp. is expecting more deals and higher spending this holiday season. Shoppers are making purchases earlier and they’re increasingly buying non-food items amid cooling inflation, Costco’s Chief Financial Officer Gary Millerchip said in an interview, adding that this bodes well for the crucial year-end shopping season. So far, Halloween sales have been strong, he said. In particular, consumer electronics are expected to be cheaper during the holidays, and sales are expected to improve as people upgrade their computers and televisions.
Costco’s bullish view is a positive sign for the industry, which has been constrained this year by a cautious consumer as purchases skew toward essentials and groceries. The holidays are the most important season for retailers as promotions and gift-buying bolster crowds and sales receipts. The holiday calendar is shorter this year, due to a late Thanksgiving, further upping the pressure. To entice shoppers, companies are focusing on offering deals and new merchandise. Amazon.com Inc., Walmart Inc., Target Corp. and others are holding discount events in October, while Walmart will also begin selling Thanksgiving food deals weeks earlier. Initial projections on holiday spending point to a slight increase in store sales and a larger jump in online spending. Costco, which reported higher-than-expected sales and profits Thursday, said toys, seasonal items and home furnishings have been popular in recent months.2
3. Volkswagen Slashes Guidance as Industry Challenges Intensify
Volkswagen cut its sales and profitability forecasts for the year, joining a growing list of European rivals in lowering their targets as the industry faces an increasingly bumpy transition to electric vehicles. The German car maker said it now expects sales of around 320 billion euros ($357.68 billion) in 2024 compared with the €322.3 billion it reported last year, as the company anticipates about 9 million vehicles will be delivered to customers, below the 9.24 million units delivered in 2023. The company previously had forecast an increase of up to 5% in sales and up to 3% in deliveries.
Earlier this month, Volkswagen said it was considering closing German factories as part of a cost-cutting and restructuring exercise designed to keep the company competitive in a challenging market. Strong European rivals and fierce competition in China from domestic producers have rung alarm bells among Volkswagen executives as labor and production costs weigh on the company’s competitiveness. In China, the company faces added pressure from Chinese carmakers gaining market share because of their aggressive pricing strategies and push for electric vehicles. Volkswagen also said Friday that operating return on sales—a closely watched measure of profitability—is expected to come in at roughly of 5.6%, below previous guidance for 6.5% to 7%.1
4. FDA Approves Bristol Myers Squibb’s Schizophrenia Drug
The Food and Drug Administration on Thursday approved Bristol Myers Squibb’s highly anticipated schizophrenia drug Cobenfy, the first novel type of treatment for the debilitating, chronic mental disorder in more than seven decades. Schizophrenia affects how a person thinks, feels and behaves, and can cause paranoia, delusions, hallucinations, and changes in emotions, movements and behavior. Those symptoms can disrupt a patient’s everyday life, making it difficult to go to school or work, socialize and complete other daily activities. Most people are diagnosed in their late teens to early 30s.
Bristol Myers Squibb expects the twice-daily pill, which will be sold under the brand name Cobenfy, to be available in late October, executives told CNBC. The drug is a badly needed new option for the nearly 3 million adults in the U.S. living with schizophrenia, some medical experts say. Only 1.6 million of those patients are treated for the condition, and 75% of them stop taking existing medications in the first 18 months because they struggle to find treatments that are effective or easy for them to tolerate, according to the drugmaker. Cobenfy could also be a huge long-term sales opportunity for Bristol Myers Squibb, which faces pressure to offset the potential loss of revenue from top-selling treatments that will see their patents expire. The drug comes from the company’s whopping $14 billion acquisition of biotech company Karuna Therapeutics at the end of last year.3
Sources:
(1) www.wsj.com
(2) www.bloomberg.com
(3) www.cnbc.com
(4) www.reuters.com
All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
Investing in stock includes numerous specific risks, including the fluctuation of dividends, loss of principal, and potential illiquidity of the investment in a falling market.
Investing in foreign and emerging market securities involves special additional risks. These risks include but are not limited to currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.
Investment advice offered through Private Advisor Group, a registered investment advisor and separate entity from The Legacy Foundation.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
The Legacy Foundation and LPL Financial do not offer tax advice.
Recent Comments