US Economy: Weekly Commentary – November 21, 2023
US Market Views Synopsis
Given the weakness of the economy, we do not expect rates to rise. We expect the Federal Reserve to cut rates in the third quarter of 2024.

The US economy is weak and the most recent data indicates that the current level of interest rates is appropriate. We observe that, although the inflation trend is decreasing, other factors such as industrial production or retail sales continue to decline, so the economy shows signs of weakness. Overall, we expect that at the next meeting on December 13, 2023, the Federal Reserve will keep rates at their current level and maintain them for a longer period than expected. Additionally, we think it is more likely that rates will be reduced around the third quarter of 2024 rather than raised.
Inflation commentary.
The CPI and PPI trend is decreasing. The Federal Reserve will hold the interest rates high for longer but downward trend in inflation removes the need for hikes in the future. The question is now when the first cut will materialise.

In October, inflation in the United States dipped from 3.7 per cent to 3.2 per cent, with the year-over-year core CPI hitting 4 per cent, its lowest since September 2021. This hints at the effectiveness of monetary policies in the fight against inflation and suggests that the current levels are adequate. These figures imply that the Federal Reserve is unlikely to pursue further interest rate hikes.

Energy concerns have been alleviated significantly, contributing to robust deflation in prices. Despite ongoing conflicts, there's minimal evidence of pricing pressures affecting inflation substantially. Housing, however, remains a significant factor impeding a swifter decline in inflation. Notably, housing prices surged by 6.7 per cent over the past year, contributing over 70 per cent to the total index increase, excluding food and energy. As the pace of these increases moderates and labour market strains surface, housing prices are expected to readjust.

Careful monitoring of inflation's trajectory remains crucial, with the market reaction of lower bond yields effectively reducing corporate financing costs, risking prolonging the interest rate cycle and reigniting inflationary pressures. We are of the opinion that rates will stay higher for longer than most expect.

Moreover, October witnessed a substantial 0.5 per cent decline in final demand Producer Price Index (PPI), marking the sharpest drop since April 2020. This decline, driven by a significant 6.5 per cent decrease in energy prices, particularly gasoline dropping by 15.3 per cent, serves as a leading indicator hinting at further inflation declines in the upcoming months. Overall, the trend in inflation is unmistakably on a downward trajectory.

Our belief is that inflation will continue its descent, with energy posing little concern in the near future. The critical area to monitor remains the housing market, where prices continue their ascent.

Consumer Spending.
Retail sales dropped after six consecutive months of increasing. The decrease in the demand strengthens our expectations that the Fed has finished its rate hikes.

Retail sales decreased by 0.1 per cent in October, the data is better than expected. The consumer cut their retail spending in October for the first time since March. However, core retail sales which is used for GDP calculations, rose by 0.2 per cent month over month in October.

October’s decline in retail spending is potentially an early sign of a slowing economy as US consumers get squeezed by higher borrowing costs, most families with lower incomes depend on credit cards to finance their purchases after ending their extra savings accumulated during the pandemic, and they continue to rack up credit card debt. Americans finally show signs of stress, and it is the best news for the Federal Reserve.

We expect an uptick now in the following months due to the season, most people will start to buy new things in the following months. However, we don’t expect consumer spending to increase a lot, the salaries are stable, and the labour market is frozen. Besides, the Federal Reserve doesn’t need to increase the interest rates because consumer spending is decreasing, the labour market struggling and inflation coming to the objective.
Labour market
The labour market shows resilience but the rise in ongoing jobless claims is a clear indicator of the increasing difficulty or lack of job affordability. The Fed will keep a close eye on jobs to determine if the policy is appropriate.

The labour market's decline persists as more individuals reapply for unemployment benefits, indicating a challenging job search landscape. Long-term unemployment has surged to 1,865k, hitting a mark unseen in nearly two years. Moreover, fresh claims for unemployment benefits have surpassed expectations, reaching 231k—a high since mid-August—though they maintain a relatively low historical standing. This sustained increase is characteristic of periods where there is a recession.

The current scenario aligns well with the Fed's interests: the labour market is moderately cooling, the economy faces challenges, and inflation is on a downward trend, alleviating the need for further rate hikes.

Our projection for the labour market anticipates a rise in unemployment in the upcoming months. Consequently, consumer spending might decline further, potentially impacting retail sales for the last quarter of the year.
Manufacturing commentary.
The manufacturing sector continues to suffer and industrial production continues to decline, slipping into a recession. We will see further contractions in future PMIs.

Manufacturing activity in the region continued to decline overall in November. The index improved by 3.1 points in November, it was – 5.9 from – 9 in October. This reading is better than the market expected. However, it is negative for the third consecutive month. The indicator for shipments turned negative, while the indicator for new orders was positive but low. The employment index suggests steady employment overall, and both price indexes indicate overall increases in prices. The future indicators suggest that firms’ expectations for growth over the next six months remain subdued.

Many companies reported price increases during the month of November. However, they expect their own prices over the next year to increase by 3 per cent, beating August expectations. For clients, the increase will be 4 per cent, a figure that does not change compared to August. Over the long term, companies' median forecast for the 10-year average inflation rate was 3.0 per cent, up from 3.5 per cent.

Industrial production in the United States contracted 0.6 per cent in October, contrasting with a 0.1 per cent increase in September. This drop is due to a 10 per cent drop in vehicle production during the period when car factories were on strike. On an annual basis, industrial production has fallen further into negative territory and is in a zone where there have been recessions and manufacturing crises in the past. So we can expect those PMIs to continue to decline further over the next few months and remain in negative territory.

The manufacturing sector in the US continues to suffer and industrial production is declining. Our outlook is for further deterioration and if this situation continues, the risk of a recession increases.
Housing market prospectus.
Somewhat strange housing market. Builders' confidence falls but construction permits and housing starts increase. Prices remain high but mortgage affordability is starting to give some respite.

Builders' confidence fell again last Thursday for the fourth consecutive month. Although mortgage rates fell 0.44 per cent in one month, they remain high and have decreased demand from home buyers. Higher interest rates and increases in insurance have also hindered financing possibilities for new housing projects.

Surprisingly, however, housing starts and building permits increased more than expected. Building permits rose 1.1 per cent from September, and home construction starts rose 1.9 per cent in October. However, September's 7.0 per cent mom jump in housing starts was revised down to just +3.1 per cent mom and Permits were revised down from -4.4 per cent to -4.5 per cent inter monthly. Even with the revision, both rose modestly in October but overall remained in a downtrend from their late-2021 highs.

Our outlook is that we are going into a somewhat tense housing market, with high mortgage rates, high prices and a shortage of supply since no one wants to sell. Prices will remain high until the labour market worsens.

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