US Economy:Weekly Commentary – November 13, 2023
US Market Views Synopsis
Given the weakness in the economy, we do not expect rates to rise. We expect the Fed to cut rates in Q3 2024.

The economy in the US is weak and the most recent data indicates that the current level of interest rates is appropriate. We note that whilst the trend for inflation is declining, other factors such as manufacturing and services purchasing managers' indices (PMIs) remain in contraction territory, consumer sentiment is dipping, and the labour market is showing signs of struggle. Overall, we expect that in the upcoming meeting on the 13th of December 2023 the Federal Reserve will maintain the rates at their current level and hold them for a longer period than generally expected. Furthermore, we think it is more likely that the rates will be cut around Q3 2024 rather than move higher.
Federal Reserve
Fed Chairman Jerome Powell has doubts about whether monetary policy is restrictive enough, with data showing that conditions have eased. Other members of the Fed see rates as sufficiently restrictive.

Powell has adopted a more hawkish stance recently, possibly in response to the drop in yields and signalling a shift from his previous position. Despite a slight easing of financial conditions from the prior month, this change is not well-received by members of the Federal Open Market Committee (FOMC).

In his recent announcement, Powell signalled his willingness to further raise interest rates, if deemed necessary to achieve the 2% inflation target. The Fed is to take a cautious approach, he said, emphasising that monetary policy decisions would be made on a meeting-by-meeting basis. Despite the growth in the last quarter, the forecast for the next quarters is moderate.

Addressing the trajectory of inflation, Powell acknowledged a decrease over the past year but noted it still remains significantly above the 2% target. While the central bank members express satisfaction with this progress, they are mindful of the considerable distance yet to reach their goal. Powell also noted that although unemployment remains low, there has been a half-percentage-point increase this year, which may be indicative of recessionary trends.

In contrast to Powell's remarks, both Barkin and Bostic concurred the current monetary policy is sufficiently restrictive. They expressed concerns about the deteriorating state of the economy, indicating a collective perception of a downward economic trajectory.

Trade balance
In September, a larger-than-expected trade deficit was reported despite the rise in exports. The deficit with China increased, highlighting the dependency of the US on Chinese goods notwithstanding the deteriorating relations between the countries.

In September, the United States witnessed a notable increase in exports, totalling $261.1 billion (+$5.7 billion vs August). Concurrently, September imports rose to $322.7 billion (+$8.6 billion vs August). This upturn in the goods and services deficit for September is attributed to a $1.7 billion expansion in the goods deficit, reaching $86.3 billion, coupled with a $1.2 billion contraction in the services surplus, which settled at $24.8 billion.

Year-to-date, there has been a marked improvement in the goods and services deficit, exhibiting a decrease of $147.4 billion, equivalent to a 20.0 per cent reduction compared to the corresponding period in 2022. Noteworthy is the 1.0 per cent increase in exports, amounting to $22.7 billion, and the 4.2 per cent decrease in imports, which contracted by $124.8 billion. The U.S. trade balance, however, experienced a deterioration than anticipated, dropping to -$61.5 billion from -$58.7 billion.

Examining the cumulative data for the first nine months of 2023, the U.S. trade deficit has contracted by 20 per cent in comparison to the corresponding period in the previous year. This contraction can be attributed primarily to a marginal increase in exports and a substantial decline in import values. Despite this overall improvement, the trade deficit with China escalated to $28.4 billion, marking its highest level since October 2022. Imports from China reached $40.3 billion, representing the highest figure since October 2022. The data underscores the continued dependence of the United States on China, while the prevailing tensions between the two nations present challenges for fostering robust trade relations.
Labour market
Those currently jobless are encountering difficulties in securing new employment, and jobless claims are consistently rising as a result. The trend indicates an overall deterioration in the labour market conditions.

Signs of weakness are emerging in the labour market. Latest initial jobless claims saw a decrease of 3,000 from the revised level of the previous week, totalling 217k. Despite this, continuing unemployment claims have risen for the sixth consecutive week, reaching 1,834 million. This trend suggests challenges in finding new employment opportunities, highlighting the existing difficulty in the job market.

We are observing a shift in the labour market condition, marked by stagnant wage growth and increasing difficulty in job search. This scenario is likely to prompt consumers to scale back their spending, a trend that could positively impact inflation. However, this reduction in real income may also lead to an increase in the default rate, presenting a dual impact on economic dynamics. Both scenarios are supportive to our stance that interest rates should be held at the current levels for the foreseeable future.
Michigan Consumer Sentiment
Consumers expect inflation to remain high, while the overall sentiment and future expectations for the economy are decreasing. With the consumer sentiment on the wane, the impetus for interest rates is to be held on the current level.

Michigan U.S. consumer sentiment has recorded its fourth consecutive monthly decline, dropping by 5.3 per cent to 60.4 in November, hitting a six-month low. The survey highlights across-the-board decreases in overall sentiment, current conditions, and future expectations. Short-term inflation expectations have surged, with consumers anticipating a rise to 4.4 per cent from the previous 4 per cent in the next 12 months. In the long term (5 to 10 years), expectations suggest an increase to 3.2 per cent, surpassing the prior 3 per cent—a level not seen since 2011. Additionally, expectations for the price of oil have elevated, reaching the highest levels this year.

"The combination of expectations for persistently high prices, high borrowing costs, and labour market weakness does not bode well for the prospect of continued strength in consumer spending and economic growth. Ongoing wars in Gaza and Ukraine weighed on many consumers as well," comments Joanne Hsu, research associate professor at the Institute for Social Research at the University of Michigan.

We anticipate a deterioration in both employment and financial conditions, leading to a rise in defaults. We do not expect significant rebounds in inflation. This serves as another rationale for the Federal Reserve to maintain interest rates at their present level.
Housing market
Whilst mortgage rates have recently dropped to 7.61 per cent, it remains prohibitively high for both new buyers and those considering refinancing. This presents a barrier to the revival of the market.

The past week witnessed a substantial decline in the average 30-year mortgage rate to 7.61 per cent (25bp reduction). This development ignited the first surge in mortgage demand since early June.

Although refinance applications experienced a modest 2 per cent uptick during the week, they still lingered 7% below the levels observed in the corresponding week from the previous year. Most homeowners seized the opportunity to refinance two years ago when rates were at historic lows, resulting in a prevailing scenario where most homeowners currently hold mortgages with rates below 4 per cent.

In addition, mortgage applications for home purchases saw a marginal 3 per cent increase, yet they remain 20 per cent lower than the figures reported a year ago. The lack of supply persists, meaning that house prices remain high. A significant number of homeowners have rates below 6 per cent and opt to retain ownership of their homes rather than putting them up for sale, exacerbating the ongoing supply shortage. Projections indicate that this shortage will persist until 2024, signalling a continued expectation of high prices in the foreseeable future.

Our outlook posits that housing prices will be high until the labour market exhibits signs of weakening. Consequently, despite the recent dip in mortgage rates, a substantial resurgence in demand for mortgages for home purchases is not anticipated.

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