Focused Investing: Economy & Markets Update

Inflation is the driving force behind the rate increases that the Federal Reserve has presented since March 2022. Inflation peaked in summer 2022, and it has been cut by more than half since the Fed raised rates from the range of 0.0%-0.25% to the range of 5.25%-5.5%, a more than 20-fold increase. Inflation is unpredictable and in the last two months, the headline inflation reading has increased at both the producer level and the consumer level. On the other hand, core inflation continues to fall. Let’s look at what happened last week and what we have to look forward to this week.

Last Week

Last week, both the Producer Price and the Consumer Price Indexes were released, and both showed a higher month-over-month increase than expected at the headline price level. Yet, core inflation was in-line with expectations. The rise of headline inflation was driven by energy prices as oil spiked above $90 per barrel in early September and has continued rising to almost $93 per barrel. At the core level, however, inflation pressures appear to be coming down as shelter and food price growth has come down over the past year. September core CPI inflation, on a year-over-year basis, declined to 4.1% from 4.3% in August, while the overall inflation measure was stable at 3.7% year-on-year.

October labor markets still look strong with first-time unemployment claims falling slightly to 209,000 from 210,000. The falling core inflation and strong labor markets did not help consumer sentiment with this measure falling from 68.1 in August to 63 in September. Consumers are becoming more concerned about their personal finances and expected business conditions over the next year.

Last Friday, third quarter earnings from Citigroup, JP Morgan, and Wells Fargo were reported and all three performed well in the third quarter. JP Morgan increased net margin through faster revenue growth. Wells Fargo reduced non-interest expense generating the higher reported net income. Citigroup increased revenue faster than expense growth, and the growth in revenues happened while reducing the size of the balance sheet. On the downside, Citi noted that credit delinquencies increased relative to the second quarter, but credit quality is not worrisome. Also, these large banks are facing a possible increase in capital requirements which will hurt profitability and potentially the ability to increase returns to shareholders through dividends and share buybacks.

What It Means

The chart below shows that spikes in inflation, as we have seen since the second half of 2020, last between three and four years. We are now three years into this spike, so if history holds, we are within one year of inflation returning to a more moderate level. Yet that level may stay above the Fed’s target of 2%. We do expect inflation to be fairly stable for the rest of the year, and then begin to decline early next year as fresher housing inflation data flow into the CPI.

The decline in consumer sentiment is worrying because of the level of credit card debt, which now stands at $1.02 trillion. Consumer sentiment surveys could be suggesting that consumers will pull back their spending more than we are currently expecting, slowing the economy even further. Consumers do not always do what they say in sentiment surveys, but when they become worried about their own finances, a pullback is more likely.

Next Week

Economic reports to come out next week include manufacturing surveys in the Northeast, retail sales, industrial production, housing starts, and existing home sales. The manufacturing surveys are expected to show a contraction in the Northeast manufacturing activity, and a reduction in existing home sales in September compared to August. Retail sales are expected to show growth, but the rate of growth is likely to be lower than the month before, consistent with our outlook of lower consumer spending.

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