Are we moving toward recession or is growth going to stay reasonably robust? That isn’t a question that will be answered this week, but economic data, starting with manufacturing surveys and ending with the September employment report, will likely be revealing. Employment has moderated in recent months but remains consistent with a soft landing…as long as it doesn’t deteriorate further. While Federal Reserve data suggests real growth still near 3%, survey data from several sources suggests some deterioration in growth rates. Hopefully, this week’s data will support one side or the other.
Last week offered little in the way of economic news. But that excludes announcements from China of a rapid fire list of stimulative steps to stop the apparent slide in economic growth. Whether they work and how long it will take them to become effective is in question, but there is little doubt they will work based on market reactions in China and in this country via China ETFs. Investors can’t lose sight that China is the world’s second largest economy by far and any set of steps that will stimulate activity there have to be viewed by investors as positive.
The recent Federal Reserve interest rate cuts had their intended effect, placating markets that the Fed wasn’t behind the curve and setting the stage for further rate increases. Fed Funds futures suggest cuts of another 50-75 basis points this year. Any expectations for next year, as measured by futures, should be taken with a grain of salt. History suggests they are as accurate as a weather forecast 12 months hence.
Thus, we remain in a quandary whether we get to a soft landing or a recession. That’s why this week’s data is important. Post the recent rate cuts, short-to-medium term rates fell in line with the decrease. But long-term rates usually reflect nominal expected growth. They inched higher mostly because markets decreased the odds of a recession in light of the 50-basis point cut in rates. The net result is that the inverted yield curve of the last several years is a thing of the past. How does that matter? It matters particularly in the housing market. Prior to the financial crisis, variable rate mortgages dominated. Once the Fed moved to zero interest policy and long-term rates declined to 1.5% or less, homeowners and homebuyers locked in 30-year loans at rates below 4%, in some cases even below 3%. That is about to change, but the change will come slowly. If Fed Fund futures are accurate, they will fall to approximately 3% within a year. If the old saw that defines longer term rates as equivalent to nominal GDP is true, 10-to-30-year rates will be closer to 4-5%. That will make the decision easy. Borrow at 3-4% for a few years with the option to refinance or borrow at 6%, plus or minus for 30 years. The change in the shape of the yield curve will therefore change the dynamics of the housing market. Indeed, that is the partial goal of lowering rates, to ensure no recession.
The stock market, historically, has been weakest from August through mid-October and strongest from mid-October until year end. While volatility has risen over the past two months, equity markets have edged higher in both August and September this year. Will that continue, according to conventional wisdom? That depends on the data. That makes this week’s numbers important. Clearly, even though we believe monetary policy matters more than fiscal steps to be taken by the next President, psychologically, the impact of the election will matter, including the balance of power in Congress. Over the past week, while Harris tried to be more specific about her economic programs and Trump hasn’t deviated as far off message as he has done at times over recent weeks, as voters we have learned precious little and the race remains deadlocked, and probably on the same path until Election Day.
The Fed’s direction is also clear. Data over the next five weeks may determine whether the November cut will be 25 or 50 basis points, but, as we noted last week, the end point is much more important than the month-to-month cuts. Thus, investors are caught in a bit of a vacuum. Data can’t accurately predict soft landing or recession, and no one really knows what the normalized rate will be when the Fed Funds rate cuts end. Until we get some confirmation, investing becomes much more company specific. A low rate of growth overall suggests pockets of both strength and weakness. The Christmas selling season, just ready to begin, will offer clues, but the important ones won’t be clear for many weeks.
Given the strength in equity markets in August and September, and given the strong likelihood that the election outcome will take days or weeks to yield a result, one should expect continued volatility without a clear trend for at least several weeks. A real resurgent rally needs strong fundamentals, signs of some acceleration. I doubt we will see that over the next few weeks. A serious decline needs recessions signals. I don’t see that forthcoming either.
With neither bulls nor bears likely to take charge, company fundamentals are likely to dominate. Third quarter earnings season begins in about two weeks. That’s when we can separate the wheat, those doing as well or better than expected, from the chaff, those facing real headwinds. This is a time when individual company performance vastly matters more than subtle changes in the economy.
Today, actress and union leader Fran Drescher is 67. Former Fifth Dimension lead singer Marilyn McCoo turns 81.