Dear Friends,
The Federal Reserve’s favored gauge for inflation rose less than expected last month providing some evidence that the bank’s actions are taking effect. However, investors still find themselves concerned that the Federal Reserve will keep rates higher for longer than previously expected. This possibility showed itself as the S&P 500 finished down for the quarter. Find out more about how the markets have been affected in this week’s newsletter.
Economy, Geopolitics, and Commodities
1. Fed Holds Rates Steady but Pencils in One More Hike This Year
Federal Reserve officials voted to hold interest rates steady at a 22-year high and revealed a divide over whether they should raise them once more this year, with most leaning toward another increase. Fed Chair Jerome Powell said that officials didn’t need to decide yet whether to lift rates again after a historically rapid series of increases over the past 18 months and as they await evidence that a recent inflation slowdown can be sustained. “Really, what people are saying is, ‘Let’s see how the data come in,’ ” he said at a news conference Wednesday. “They want to be convinced. They want to be careful not to jump to a conclusion.” Fed officials also indicated they expect to keep rates higher for longer through 2024 than they anticipated earlier this year.
Stock markets slid after the meeting, with the Dow Jones Industrial Average down 77 points, or 0.2%, and the S&P 500 decreasing 0.9%. Yields on the 2-year Treasury note rose to 5.118%, the highest level since 2006. Fed officials raised their benchmark federal funds rate at their previous meeting in July to a range between 5.25% and 5.5% to combat inflation by slowing economic activity. They began lifting rates from near zero in March 2022. Projections released at the conclusion of the Fed’s two-day policy meeting showed 12 of 19 officials favor raising rates one more time this year, while seven think they can leave them unchanged. They meet Oct. 31-Nov. 1 and again in December. “The fact that we’ve come this far lets us really proceed carefully,” said Powell. He used those words—“proceed carefully”—six times during Wednesday’s news conference, a sign of heightened caution about lifting rates.
2. US Inflation Outlook Brightens as Underlying Price Pressures Subside
Underlying U.S. inflation moderated in August, with the annual rise in prices excluding food and energy falling below 4.0% for the first time in more than two years, welcome news for the Federal Reserve as it ponders the monetary policy outlook. The battle against inflation is, however, far from being won as the report from the Commerce Department on Friday showed overall prices were still elevated, partly due to higher gasoline prices.
While the economy remains strong, consumer spending is slowing, which combined with cooling underlying price pressures raised hopes that the U.S. central bank will not hike interest rates in November. The consumer spending and inflation report is probably the last official economic data release before an expected partial shutdown of the U.S. government due to begin after midnight on Saturday. A lengthy data blackout also could make the Fed reluctant to raise interest rates at its Oct. 31-Nov. 1 meeting.
The personal consumption expenditures (PCE) price index, excluding the volatile food and energy components, edged up 0.1% last month. That was the smallest rise since November 2020 and followed a 0.2% advance in July. Economists polled by Reuters had forecast the core PCE price index would climb 0.2%. In the 12 months through August, the so-called core PCE price index increased 3.9%. It was the first time since June 2021 that the annual core PCE price index was below 4.0%. The core PCE price index rose 4.3% in July.
Slowing underlying inflation was reinforced by two new price measures, the PCE price index excluding food, energy and housing, and PCE services excluding energy and housing, introduced by the government with the August report. The PCE price index excluding food, energy, and housing also gained 0.1% last month after rising 0.2% in July. PCE services excluding energy and housing inflation rose 0.1%. The so-called super core inflation climbed 0.5% in the prior month. Policymakers are watching the super core price measure as they try to gauge progress in their fight against inflation. The inflation outlook was also bolstered by a survey from the University of Michigan showing consumers’ 12-month inflation expectations fell to 3.2% this month, the lowest since March 2021, from 3.5% in August. Consumers’ long-run inflation expectations slipped to 2.8% from 3.0% last month.
3. Bill to Avoid Government Shutdown Defeated in House
House Speaker Kevin McCarthy’s bid to avert a government shutdown ran headlong into opposition from dissident conservatives on Friday, as GOP holdouts sank a short-term spending bill designed to unite the party in talks with Democrats. The bill failed in the Republican-led House with 198 in favor and 232 against, with 21 GOP lawmakers joining all Democrats in voting No. The defeat marked the latest embarrassing floor setback for McCarthy and underscores the bind facing GOP leadership. With a narrow 221-212 Republican majority in the House, McCarthy has repeatedly crafted legislation to win over the hard-line conservatives in his conference—only to see the bills fail anyway. The intraparty deadlock has left Republicans with no clear path forward, sidelined any talks with Democrats, and put McCarthy’s job at the top of the party in peril.
McCarthy went ahead with the vote even as it faced long odds of passing, serving as the last major legislative card to play before a likely shutdown this weekend. He had cast the vote as a test of holdouts’ willingness to legislate, pointing to the border security measures as a key sweetener. Even had it passed, the House measure stood no chance of clearing the Democratic-controlled Senate, which is advancing a plan to extend fiscal 2023 funding at current levels until Nov. 17 while providing $6 billion apiece for Ukraine and disaster relief. Still, Republican supporters had hoped that passing the GOP short-term plan would allow McCarthy to enter negotiations with the Senate with a stronger hand.
The next steps were unclear, but some Republicans were betting that any shutdown would be relatively short-lived once lawmakers absorb the consequences of a prolonged impasse. Starting next week, hundreds of thousands of government workers will be furloughed, and others will be forced to work without pay until the standoff is resolved. The Defense Department has projected that mid-October paychecks for the military will be delayed if Congress doesn’t enact legislation by Oct. 11.
4. Oil Mixed Amid Macroeconomic Concerns
Oil prices were mixed on Friday in a volatile trading session due to macroeconomic concerns and profit taking, but were set to rise about 30% in the quarter as OPEC+ production cuts squeezed global supply. Front-month Brent November futures were up 5 cents at $95.43 per barrel at 12:22 p.m. ahead of the contract’s expiry later in the day. The more liquid Brent December contract was down 11 cents to $92.99 per barrel. U.S. West Texas Intermediate crude (WTI) was down 4 cents, or 1%, to $81.57 per barrel. WTI futures were up $1 a barrel earlier in the session, before swinging lower to trade $1 below Thursday’s close price. WTI is set to climb 1% and Brent 2.5% on the week.
With oil futures inching closer to the $100 a barrel threshold, investors could be taking stock of the current rally given ongoing macroeconomic concerns. “WTI has been the belle of the ball, but today it’s losing its lustre,” said John Kilduff, partner at Again Capital LLC in New York, citing profit taking and economic concerns. In the third quarter, Brent crude futures are set to rise 27%, while U.S. crude futures should settle 30% higher. Investors may be looking ahead to a potential partial U.S. government shutdown on Sunday. A shutdown would be an “unnecessary risk” to a resilient U.S. economy, top White House economic adviser Lael Brainard said on Friday.
5. China’s Economic Woes Embolden Calls for Deeper Reforms
China’s economic slowdown is polarizing government advisers over the best way forward, with advocates of structural reforms now emerging from the shadows in a challenge to others calling for more state spending to shore up faltering growth. The rare debate among advisers, who influence policy-making but do not wield direct power, comes as global markets scramble for clues on how authorities will halt a downturn that has left millions without jobs, forced investors to flee and the yuan to tank. A dribble of piecemeal support measures from Beijing in recent months has raised questions about the tough choices China’s new economic leadership now faces over whether to prioritize short-term relief or long-overdue reforms.
Advisers calling for immediate stimulus argue the central government’s low debt means it can shoulder the burden with municipalities to finance infrastructure and other spending to rev up activity. But pro-reform advisers argue the stimulus playbook that helped drive growth for decades has run its course and that bolder structural changes to the economy are now needed. Both camps argue their proposals should be treated with urgency by policymakers, ahead of the annual Central Economic Work Conference, an agenda-setting gathering of top leaders expected in December.
The world’s second-largest economy is showing some signs of stabilizing after a flurry of modest policy measures, but the outlook is clouded by a property downturn, aging demographics, high debt, and geopolitical tensions. The Asian Development Bank on Wednesday trimmed its growth forecast of China to 4.9% from 5.0% in July due to the weakness in the property sector. While structural changes require political will, pro-reform advocates argue that without them, China will struggle to sustainably revive confidence in its economy, especially the private sector.
Financial Markets
1. Dow Sheds More Than 100 Points Friday
The Dow Jones Industrial Average retreated on Friday as investors followed the latest news about a potential government shutdown and ended what has been a tough month for stocks. The blue-chip average lost about 158.84 points, or 0.47% to finish at 33,507.50, led down by Travelers Companies. The S&P 500 dropped 0.27% to 4,288.05. The Nasdaq Composite traded up 0.14% to 13,219.32.
The latest reading of the personal consumption expenditures price index, which is the Federal Reserve’s preferred inflation metric, came Friday morning. So-called core PCE, which strips out volatile food and energy prices, rose 0.1% in August and 3.9% annually. Economists polled by Dow Jones expected that the core PCE would advance 0.2% on a monthly basis and 3.9% year over year. But investor concerns about the potential for a government shutdown weighed on the market later in the session. House GOP leaders failed to pass a short-term spending bill on Friday, bolstering fears that federal lawmakers wouldn’t reach an agreement on time.
The market saw sharp losses for the trading month and quarter, both of which concluded with Friday’s close. The S&P 500 finished the month down 4.9% and the quarter lower by 3.7%. The Nasdaq Composite was off 5.8% in September, and down 4.1% for the quarter. Both posted their worst months this year. The Dow notched a 3.5% decline this month and a 2.6% fall for the quarter. The Dow and S&P 500 ended the week down about 1.3% and 0.7%, respectively. The Nasdaq Composite ended 0.06% higher.
2. UAW Announces New Strikes at GM and Ford Plants, Spares Stellantis
The United Auto Workers union will expand strikes against General Motors and Ford Motor to two U.S. assembly plants at noon ET, UAW President Shawn Fain said Friday. The additional strikes will target Ford’s Chicago Assembly in Illinois, which produces the Ford Explorer and Lincoln Aviator SUVs, and GM’s Lansing Delta Township plant in mid-Michigan that produces the Buick Enclave and Chevrolet Traverse crossovers. The plants are important ones for the companies, however not as profitable or crucial as facilities that produce the automakers’ pickup trucks. Fain said Chrysler parent Stellantis was spared from additional strikes because of recent progress in negotiations with that company.
About 6,900 autoworkers will take part in the latest wave of work stoppages, joining roughly 18,300 workers who are currently on strike for the union. That means about 25,200 employees, or roughly 17% of UAW members covered by the expired contracts with the Detroit automakers, will be on strike as of noon. “To restore the balance of power, we have to restore the strike,” Fain said Friday, citing several other UAW strikes aside from the Detroit automakers.
GM in a statement Friday said it had yet to receive a “comprehensive counteroffer” from union leadership to a contract proposal made last week. “Calling more strikes is just for the headlines, not real progress. The number of people negatively impacted by these strikes is growing and includes our customers who buy and love the products we build,” Gerald Johnson, GM’s head of global manufacturing, said in the statement. “We’re here to reach an agreement so we can all get back to work, and that remains our 100% focus.”
3. Energy Stocks Are Hot. The Fourth Quarter Will be Trickier.
With oil prices nearing $100 a barrel, energy stocks are finishing up an exceptionally strong third quarter. Exxon Mobil hit a record high on Wednesday, and energy is the only sector of the S&P 500 trading in positive territory over the past month. But the months ahead could well be trickier. Oil traders are already very bullish on the commodity, making it less likely that new money will move the needle for the stocks. And some analysts expect supply-demand dynamics to be less bullish in the coming quarter.
There’s also a disconnect between oil stocks and the commodity, and that points to underlying problems. Brent crude futures, the international benchmark, were trading around $96 on Thursday, up 27% since the end of June, while the SPDR S&P Oil & Gas Exploration & Production ETF is up 17% in the same period.
One reason the stocks have lagged behind the commodity, and may continue to, is that traders expect oil prices to be lower next year. Brent crude futures expiring a year from now are trading around $84 per barrel, $12 below current prices. Oil stock gains are thus “tempered by a backwardated price structure where the long-dated price is the only barometer of what the market will discount,” wrote Bank of America analyst Doug Leggate. The term “backwardated” describes a market where near-term prices are higher than prices in the future.
Oil prices right now are being lifted by Russia and Saudi Arabia, which have announced they will cut production through the end of the year to keep prices high. Both countries could continue to keep their production low next year, but there’s also a chance they’ll start producing more, thereby causing downward pressure on prices. “While oil above $90 is clearly positive for near-term sector free cash flow, longer-dated prices depressed by a spare capacity overhang remains a tangible headwind to valuations,” Leggate wrote.
In addition, some analysts expect oil demand to get weaker. “Demand risks are shifting to the downside: With pump prices surging and a seasonal travel peak now behind us, a greater share of demand in the fourth quarter will be concentrated in sectors more sensitive to economic growth,” wrote Natasha Kaneva, head of the global commodities strategy team at J.P. Morgan, in a note last week. “We already observe some tangible slack in demand.”
4. Intel’s High-Volume EUV Production Begins at Irish Plant
Chipmaker Intel said on Friday it had begun high-volume production using extreme ultraviolet (EUV) lithography machines at its $18.5 billion plant in Ireland, calling it a “landmark” moment as it seeks to regain ground on its rivals. Once the world’s leading chip manufacturer, Intel has lost the lead to Taiwan Semiconductor Manufacturing Co, but says it is on track to regain it with manufacturing technology it says will rival the best from the Taiwanese group.
The EUV tools, which are theoretically precise enough to hit a person’s thumb with a laser pointer from the moon, will play a key role in meeting Intel’s goal of delivering five generations of technology in four years, the U.S. company said. Intel’s general manager of technology development Ann Kelleher told Reuters it was on track to meet this target, with two manufacturing processes now complete, a third “coming rapidly”, and the final two making very good progress.
The plant, in the town of Leixlip outside Dublin, is the first high-volume location for the group’s Intel 4 manufacturing process, which uses EUV. The technique will produce its forthcoming “Meteor Lake” chip for laptops, which will pave the way for AI PCs. The EUV machines, made by Dutch manufacturer ASML, are as big as a bus and cost around $150 million each. There are currently seven in the plant, where a constant stream of overhead robots, each costing the same as an average BMW car, whiz along 22km of track delivering silicon wafers from tool to tool. At the opening of the Irish plant, Intel chief Pat Gelsinger described it as the “best day for Europe”.
Sources:
(1) www.bloomberg.com
(2) www.factset.com
(3) www.wsj.com
(4) www.nytimes.com
(5) www.reuters.com
(6) www.cnbc.com
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Economic forecasts set forth may not develop as predicted.
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Investment advice offered through Private Advisor Group, a registered investment advisor and separate entity from The Legacy Foundation.
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