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The holiday shopping season has officially kicked off and it’s likely that a less festive Santa than we have seen in recent years will be coming down the chimney. For sure, the nation’s collective stockings will not be filled with coal, but the presents will be less plentiful and generous than in 2022. We don’t expect consumers to zip up their wallets and purses entirely, but they are running out of the fuel that pumped-up spending last year and the year before. Job growth is slowing, the pandemic-era excess savings are mostly depleted, banks are tightening credit, student loan payments have restarted and borrowing costs have spiked.
The American public may not be feeling better about things, but economists clearly are. Most households think the economy is going in the wrong direction, and consumer confidence in one prominent survey is currently at recession levels. To be sure, there is a heavy political component in many of the surveys. Democrats, for example, are far more upbeat than Republicans regarding the health of the economy, but that sentiment is flipped on its head when Republicans occupy the White House. While economists are also influenced by their political beliefs, they presumably rely on hard data and are more objective when presenting their outlooks.
It would be hard to find another week that had as many positive developments as the one just passed. On the political front, the prospect of an imminent government shutdown was averted as the House passed a bifurcated funding bill that was approved by the Senate and White House. On the economic front, reports of lower inflation and slower consumer spending put the economy more firmly on the path to a soft landing. That virtuous combination, in turn, likely means that the Federal Reserve’s rate-hiking campaign has come to an end. For investors, all the above made for a joyous occasion, and the markets celebrated by sending stock prices sharply higher and yields lower.
There was little in the way of market-moving data out this week, with the lagging consumer credit report highlighting the weekly calendar. That said, credit is the lifeblood of the economy and, crucially, is receiving increasing attention, mostly negative. The three major borrowers – governments, businesses and consumers – all made their presence felt this week, albeit only one – the government – had a meaningful market impact. Despite the good vibes coming out of the Treasury's announcement that it would be issuing fewer longer-term securities to fund operations than expected, the auctions of 3-,10- and 30-year issues this week were met with a tepid response from investors, and bond yields retraced some of the steep declines over the past three weeks, which saw the bellwether 10-year year yield fall from five percent to 4.5 percent. Still, at around 4.62 percent at the end of the week, it retained most of the recent decline, preventing an abrupt rebound in private yields – most notably mortgage rates – which also followed Treasury yields down in recent weeks.
The forward momentum provided by the turbo-charged growth in the third quarter is rapidly dissipating. To be sure, the economy is hardly falling off a cliff, but if early data for the fourth quarter is any indication, its growth engine is downshifting markedly. The soft jobs report for October, released Friday, highlighted this trend and overshadowed the Federal Reserve’s policy meeting this week. As expected, the Fed made no change in the federal funds rate, which now looks highly prescient in the face of this week’s data. While it would be premature to expect the Fed to start cutting rates any time soon, the jobs report, as well as the latest surveys of manufacturing and services activity, weaken the odds of another rate increase. Investors are clearly echoing that sentiment, as the bond and stock bulls rampaged through the financial markets this week.
As advertised, the U.S. economy turned in a stellar performance in the third quarter, staging the strongest growth rate since the fourth quarter of 2021. While the monthly tracking data foreshadowed a powerful reading, the actual result still exceeded expectations. That said, no one is saying the economy is off to the races. In fact, just the opposite is the case. The consensus view is that the third quarter was juiced by forces that that are poised to wane, even as growth-retarding headwinds are stiffening. But even as the growth engine is set to downshift, recession expectations that were so prevalent a few months ago are being pushed back into next year, with a groundswell of sentiment believing it can be avoided completely.
With the 10-year Treasury yield edging closer to five percent this week, the highest since 2007, the Fed’s transmission mechanism is clearly working. As Fed Chair Powell reiterated at a speech before the Economic Club of New York on Thursday, monetary policy works through the financial markets. At times, the markets do not cooperate, as was the case between 2003 and 2005 when long-term yields refused to budge despite 150 basis points of Fed-induced rate increases that then-Fed chair Greenspan famously referred to as a “conundrum.” Of course, times were much different then, as core inflation had been hovering around two percent for almost a decade and the unemployment rate ranged between five and six percent since coming out of the 2001 recession. Against that backdrop, investors felt little urgency to demand a higher yield premium to tie their funds up for a long period. Indeed, the 150 basis points of rate increases the Fed put into place was mainly designed to prevent inflation from rising, as the economy was growing at a brisk pace.
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