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On Inflation, Capital Spending & Economic Resilience
Today, Ed and Elias take a deep dive into core inflation, i.e., minus volatile food and energy prices. The Fed’s preferred measure, the core PCED, justifies tightening monetary policy—both the recent September rate hike and presumably future ones provided that underlying inflation remains elevated. … The alternative measure, the core CPI, is structured differently, causing it to diverge from the core PCED in response to price changes in AI-related spending, financial services, and shelter. … The US economy should remain resilient during this tightening cycle, as GDP growth has become increasingly desensitized to interest rates. That’s one reason the recession widely expected in 2022 and 2023 never happened.
ECONOMIC WEEK AHEAD: September 28 - October 2
The week ahead is jam-packed with labor market data releases, capped off by September's employment report (Fri). August's PCED and the third estimate of Q2 GDP arrive Wednesday, along with BEA's annual revisions, followed by ISM's M-PMI on Thursday. FedSpeak continues, with Richmond Fed President Tom Barkin, Governor Lisa Cook, Chicago Fed President Austan Goolsbee, Minneapolis Fed President Neel Kashkari, and New York Fed President John Williams among those scheduled to speak. They will likely weigh in on September’s FOMC rate-hike decision and the recent rise in global bond yields. Overseas, the Reserve Bank of Australia will issue the week's only scheduled interest-rate decision. China's official PMIs and flash Eurozone inflation figures are also due out, with European Central Bank President Christine Lagarde making several public appearances. Micron reports earnings on Wednesday. Here’s more: (1) Employment. September's employment report (Fri) is the headliner. Payrolls rose 162,000 in August, lifting the three-month average to 71,300 (chart). Private payrolls accounted for 127,000 of the gain, led by leisure & hospitality (62,000) and goods-producing industries (41,000). We expect a figure close to 100,000 for September. Fed Chair Kevin Warsh said at his September 16 press conference that the unemployment rate, at 4.1% in August, is "basically running consistent with full employment." He added, "I don't believe that we need to do harm to the labor markets to achieve our [inflation] objective." Challenger's September layoff announcements (Thu) follow August's 52,900, still low by historical standards (chart). Layoffs probably remained light last month, according to initial unemployment claims, which held at a four-week average of 203,600 as of September 18. Warsh noted that claims are running at levels consistent with full employment. August's ADP private payrolls rose 38,000, below the 47,000 consensus and July's upwardly revised 46,000. September's ADP report (Wed) may show improvement, with ADP's weekly readings rising for three straight weeks to a four-week average of 20,000, up from a late-July bottom of 8,250 (chart). That pace equates to roughly 85,000 a month. July's JOLTS data showed job openings at 7.3 million, with the share of consumers saying "jobs are plentiful" at 27.0% in August, both consistent with a stable labor market (chart). We expect more of the same in August's JOLTS report (Tue). (2) GDP. The third estimate of Q2 GDP (Wed) follows the second estimate of 1.5% saar, with the GDP price index up 6.4%. It arrives with BEA's annual update, which will revise prior data. The Atlanta Fed's GDPNow model estimated Q3 growth at 5.0% as of September 25, led by an 18.5% jump in business equipment spending (chart). (3) PCED. August's core PCED (Wed) follows July's 3.3% y/y. That was well below August’s 4.6% pace of core PPI final demand for personal consumption (chart). The core CPI was 2.4% in August. Based on the CPI and PPI data for August, Warsh estimated August’s core PCED at about 3.2% y/y and headline PCED at about 3.6% y/y. The Cleveland Fed's Inflation Nowcasting model projects hotter readings of 3.4% and 3.8%, respectively. (The model’s m/m rates are 0.34% and 0.27%.) (4) M-PMI. ISM's M-PMI (Thu) was 54.6 in August, with the NM-PMI at 55.4 (chart). S&P Global's flash M-PMI for September jumped to 57.0 from 53.9, suggesting another strong ISM reading. The flash composite rose to 58.4, the strongest since July 2021. Input costs across goods and services rose at the fastest pace since October 2022. S&P 500 forward earnings continue to rise, increasing 37.2% y/y in September, suggesting more upside for the M-PMI (chart). (5) Earnings. Micron reports fiscal Q4 results (Wed) for the quarter ended in August. Based on analysts’ consensus estimates, they expect revenue of $50.8 billion, up from $11.3 billion a year ago. EPS is expected at $31.45, within management’s guidance range of $30.00-$32.00 and up from $3.03 a year earlier. Yet the stock has fallen 11.1% since peaking after its last quarterly earnings report back in June (chart). Analysts expect Micron's net income margin to widen to 70.7% in fiscal Q4 from 69.6% in Q3. Its forward profit margin has reached 71.6%, well above its 2018 peak around 42% (chart).
GLOBAL MARKETS CALL: Interest Rates Are Troubling
I. Global Economy The global economy has been surprisingly resilient so far this year. There were dips earlier this year, when the Middle East war was in full swing; but in recent months, global industrial production and exports have rebounded to their record highs from before the war (chart). The All Country World MSCI forward revenues per share has continued to soar to record highs this year (chart). The All Country World ex-US MSCI is up a very solid 10.0% y/y, with forward earnings up a record 39.7% (chart). II. Global Interest Rates The significant increase in oil prices so far this year hasn't knocked the wind out of the global economy’s sails. The question is whether rapidly rising interest rates will do so. The rapid rise in 2-year government note yields worldwide signals that major central banks need to raise their policy rates further in response to the inflationary impact of higher-for-longer oil prices resulting from the recent re-escalation of the Middle East war (chart). Unfortunately, these higher rates also exacerbate the outlook for large government deficits worldwide. A diplomatic settlement of the war would certainly help to bring down oil prices and interest rates. However, President Donald Trump has reportedly rejected an offer by Iran to reopen the Strait of Hormuz and end the conflict. He intends to resume bombing Iran after the midterm elections if Iran doesn't agree to dismantle its nuclear program. That means higher-for-longer oil prices, sticky inflation, and more central bank tightening. The synchronized worldwide rise in bond yields this year likely stems from factors beyond inflation. In our September 17 QuickTakes titled “Global Bond Rout Made In Japan?,” we wrote, "Higher Japanese interest rates and likely further yen appreciation have been forcing traders to unwind their yen-carry trades. This might explain the rout in the global bond market since 2024." In Japan, the 2-year government note yield suggests that the Bank of Japan needs to hike its official policy rate three more times to 2.00% from 1.25% currently (chart). III. Global Stock Markets Meanwhile, global stock markets are rising together to new record highs even as bond yields rise to multi-decade highs (chart). The global stock bull market is driven by fabulous earnings momentum (FEMO) not just in the US, but worldwide (chart). How can that be? Perhaps the AI buildout might explain why this is happening. IV. Go Global vs Stay Home On a ytd basis, Stay Home and Go Global have performed about the same. In dollars, the ACWX is up 14.5%, while SPY is up 13.5% (chart). EMXC (39.2%) has outperformed EEM (24.3%). The same rankings have held so far during September (chart). V. Weekly Focus (1) The OECD recently released its interim economic outlook, noting that global growth has held up better than initially feared following earlier Middle East conflict escalation and crude oil spikes. Global GDP growth for the year is projected at 2.9% (a slight 0.1% upward revision). (2) Flash PMI releases across the Eurozone and the UK highlight a two-speed overseas environment: Domestic service sectors continue to expand at a modest clip, while export-oriented manufacturing remains hamstrung by weak external demand and lingering supply-chain cost frictions (chart). (3) OECD data tracking the past week signal that the recent moderation in oil prices (retreating below $100/bbl) was heavily cushioned by the strategic release of global oil reserves, a sharper-than-expected decline in China's energy imports, and a pivot toward alternative fuels like coal (chart).
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