In the week ending September 13, all three major U.S. stock indexes posted significant gains, with the Nasdaq surging nearly 6%, marking its best weekly performance of the year, while the S&P 500 rose 4.02% and the Dow added 2.6%. Despite recent market volatility, U.S. stocks rebounded sharply.
On the economic front, the U.S. Department of Labor reported on September 11 that the Consumer Price Index (CPI) for August increased by 0.2% month-over-month, with the annual rate cooling from 2.9% in July to 2.5%, the smallest annual gain since February 2021. This aligns with the Federal Reserve's 2% inflation target, mainly driven by falling energy prices. Meanwhile, on September 12, the Producer Price Index (PPI) for August also rose by 0.2%, meeting expectations. These inflation indicators suggest a softening trend, reinforcing market expectations for a rate cut at the Fed's September meeting. Additionally, initial jobless claims increased slightly to 230,000, indicating a cooling labor market.
How will the cooling U.S. labor market impact the Fed's upcoming policy decisions? And what will be the effect on emerging markets if the Fed begins cutting rates? In this edition of “Wall Street Frontline”, we invited Nasdaq Chief Economist Phil Mackintosh to provide insights into these key questions.
Wall Street Frontline: let's start with the job report. The August job report showed slower than expected job growth alongside with downward revisions in June and July. So how would you interpret the data? Is this really like a truly cooling down labor market or are there any underlying factor that shows resilience?
Phil Mackintosh: Right, so it is really a cooling down labor market, but I think what's important is it's cooling from a really hot level. So you remember not that long ago we had two jobs for every one person looking for work and when that was happening, we had a lot of wage inflation, we had a lot of quitting, people just moving one job to another which was hard for companies to manage.
Where we've got to now, it's much closer to a normal supply and demand balanced labor market. So even though the unemployment rate is ticking up and it's 4.2 percent now, it was 3.4, the reality is it's a more normal job market now. It's much easier for companies to manage their workforce.
Labor wages is much more consistent. So that's taking a lot of heat out of inflation and from a company's perspective, it's actually easier for them to manage margins.
Wall Street Frontline: As you just talked about inflation, according to a Labor Department report, inflation in August actually declined to its lowest level since early February 2021 and right now there's ongoing debate on whether the Federal Reserve should implement a 50 BPS cut in their next upcoming meeting.
Phil Mackintosh: Yeah, and the debate's kind of 50-50 whether we think it's for sure we're going to get a cut, but we're going to get 25 basis points or 50. And in reality, I think it would probably shock the market a bit if we got 50, but I don't think it's a bad thing if we see 50 because we've got inflation to your point now at 2.5 percent. The Fed funds are still at 5.5 percent.
That's 300 basis points of cuts if we're going to get down to something more normal and sort of not expansionary, but not contractionary. So for the Fed to start thinking about cutting rates, we've got 300 basis points to go. I don't think 50 would be a bad place to start.
Wall Street Frontline: So what is your outlook for the Federal Reserve's monetary policy trajectory in the last quarter of 2024?
Phil Mackintosh: Yes, so the market's pricing in 100, maybe 125 basis points of cuts. We've got three meetings, so we're going to have some 50s somewhere based on what the market is saying. If you look at longer term, with the demographics in America, the population is only just growing, so everyone's aging out.
There's not a lot of demand for new houses and things like that. So realistically, with inflation running at 2, 2.5 percent, we probably need to get rates down to that 3, 3.5 percent rate, which is about what the 10-year is saying. So that's a lot of cuts.
I think by the time we get two years from now, we should hopefully have rates down to that sort of 3.5 level, which is, like we said, 200 basis points of cuts in total. And I think if you're a small business owner, they're the ones that have been paying the most increased interest because of the Fed's hikes. You really want that to happen sooner rather than later, and especially before some of your fixed rate debt comes due for new financing, and you have to reset to the higher rates, which we've seen happening this year.
Wall Street Frontline: Right now, the Federal Reserve is still trying to realize a soft lending scenario, while at the same time, the labor market is cooling down, as you just mentioned. So do you think the U.S. economy is heading into that right direction of soft lending, or have you seen some signs of recession?
Phil Mackintosh: So I think what we've got to be careful or watch for, at least, is the layoffs have actually not picked up. They're at pretty much record lows for the last couple of decades.
So the increase in unemployment is because people are coming into the labor force, looking for work with all those increased wages, not because people are being let go. And that's a massive difference in terms of where the spending patterns change. If you lose your job, chances are you stop spending, you start saving.
If you're coming into the labor force and you get a job, you're going to start spending. So at the moment, what we're seeing in the labor market, it's more of a normalization than a real worrying softening. But for sure, we've got to watch those layoffs, because if that starts to happen, then we could see sort of a feedback loop where consumer spending slows down.
And that's really what's joined the whole economy in the U.S. and given us the strength that we've had this year.
Wall Street Frontline: In the last quarter of 2024, do you foresee some headwinds, especially in manufacturing and services? Or do you still think consumer spending would provide a lot of support to U.S. economy?
Phil Mackintosh: Yeah, so real wages has actually been growing. So real wages is after inflation, because inflation has come down and wages have been going up. So that's given the consumer sort of a third leg of extra spending. The second leg was the fact that they have their mortgage rates locked. So the actual mortgage rates haven't been affected by the Fed policy. And the first leg was all the COVID stimulus. So the consumer has kind of got a decent financial position. Even with the increased credit card usage, credit card debt as a percentage of income is still below record levels.
The actual household balance sheets are better than they have been in the past. So household and consumer side looks pretty good. I think where there's a bit more weakness is the small cap companies, like we said, they've got more variable interest. They've been paying more interest expense. They've actually had a bit of an earnings recession. And that's why they've been underperforming in the market too.
Wall Street Frontline: If we look globally, so how do you think the potential rate cuts by Federal Reserve would impact emerging markets?
Phil Mackintosh: I think there's a little bit of a pro and a con to that, right? Because if rates start coming down, the attraction of the U.S. dollar and the strength of U.S. dollar might weaken. And so that's going to make the U.S. easier to compete with products because the dollar is going to be a little bit weaker. But at the same time, with rates coming down, paying off some of that debt is going to be cheaper for a lot of emerging markets, countries that have borrowed in U.S. dollars and are paying back U.S. interest rate debt.
So I think emerging markets might benefit from the fact that the dollar is weakening, but at the same time, the U.S. economy is weakening. And so a lot of emerging markets are producers and manufacturers. And if that's weakening, maybe the demand for some of their goods will be weaker as well. So it's a little bit of a pro and a con.
Wall Street Frontline: So the last question is about AI. So with the AI-trend technology stocks, especially like leading companies like Nvidia, they have faced significant sell-off pressures recently. How do you see the technology sector responding to the potential Federal Reserve rate cuts? And what role do you think higher valuation would play in this volatility?
Phil Mackintosh: Yeah, so the flip side of the small cap companies paying more interest is that a lot of the large cap companies, back when zero interest rates were around, locked in, fixed rate, long-term debt. So actually, if you look at the S&P 500 as a complex, the interest expense hasn't gone up that much. So the interest cost or the interest benefit of rates coming down isn't really going to affect the large cap space from an expense perspective much.
Typically, rates coming down is actually a valuation tailwind, because you sort of work out what the cash flows in the future are going to be, and you discount it by the interest rate. And if the interest rate goes down, the valuation goes up. I think the flip side right now is those companies have been delivering really solid growth in real earnings, and the market has priced them, not quite for perfection, but basically been pricing them for phenomenal growth in real earnings, which they keep delivering.
There's a point where maybe there's not enough capacity even to create the chips that people might want to buy. So the rate of growth is going to slow, even if they keep growing. That's going to slow down the rate that their price goes up.
The flip side, though, is small cap is starting to see some outperformance, and that's because their interest expense will probably come down with interest rates coming down. |
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