International Conflict, Elevated Rates Assist Fed with Policy Firming

International conflict is dominating headlines and the markets as investors try desperately to separate out geopolitical risks and the humanitarian impact with the potential longer-run implications for the international and domestic economy. In response to the weekend’s attacks by Hamas, the Israeli military has reportedly activated 300,000 reservists in a?“massive mobilization.”?

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The White House has not yet spoken or held a formal press conference on the evolving situation, however, in a statement released Monday evening, President Biden directed a team to work with Israel counterparts "on every aspect of the hostage crisis, including sharing intelligence and deploying experts from across the United States government to consult with and advise Israeli counterparts on hostage recovery efforts."?

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Biden is expected to make a formal statement today at 1:00 p.m. ET this afternoon. ?

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Heading into the fourth week, the United Auto Workers strike has expanded to Mack Trucks, which is owned by Volvo. After rejecting a proposed five-year labor contract, nearly 4k workers walked off the job, taking the total number of UAW members on strike to over 30,000.??

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The impact of the strike is going to first and foremost depend on the depth and duration. The more prolonged and extensive, the larger the potential impact of the walk-offs with already estimates suggesting billions lost in terms of wages and production. Furthermore, the impact of the latest strikes have yet to filter through into the nonfarm payroll calculations, but will expectedly be fully compensated for in the Q4 report.? ?

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Of course, as we’ve noted before, from a policy standpoint, while individual union strikes are unlikely to move the needle in terms of aggregate wage data or monthly rate decisions, this growing theme of higher compensation demands speaks to the ongoing, sticky nature of services costs and can cause ripple effects of rising expectations for both compensation and broader inflation, which in turn complicates the Fed’s ability to reach its inflation target.? ?

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According to Dallas Fed President Lorie Logan, the recent backup in rates may preclude the Fed from having to raise rates further. Speaking at the National Association for Business Economics (NABE) meeting in Dallas yesterday, Logan said,?"I expect that continued restrictive financial conditions will be necessary to restore price stability in a sustainable and timely way,"?adding that financial conditions have become?"notably"?tighter in recent months.?

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Also, speaking yesterday at the NABE meeting in Dallas, Fed Governor Philip Jefferson indicated higher longer-term yields may mitigate the need for additional rate hikes, at least next month.?“I will remain cognizant of the tightening in financial conditions through higher bond yields and will keep that in mind as I assess the future path of policy,”?Jefferson said.

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While some investors have interpreted such comments as a notably more dovish message, or a shift in sentiment, this is entirely consistent with the Fed’s longstanding view of?“total”?policy firming and the notion of?“higher for longer.”?Reaching a sufficiently restrictive level of policy has always been seen as a compilation of Fed rate hikes and an organic adjustment to credit and market conditions. Thus, if sustained higher rates or an increase in financial institutions’ credit standards do some of the Fed’s work by offering the equivalent of 25bps or 50bps of further rate hikes, the Fed may not need to adjust policy as much as previously expected. ??

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Continuing the myriad of Fed speak, today at 9:30 a.m. ET, Atlanta Fed President Raphael Bostic will speak on the outlook?for the U.S. economy at the American Bankers Association Annual Convention, and at 1:30 p.m. ET, Fed Governor Christopher Waller will speak at a monetary conference hosted by George Mason University’s Mercatus Center. Later, at 3:00 p.m. ET, Minneapolis Fed President Neel Kashkari will participate in a town hall hosted by Minot State University in Minot, North Dakota. And, finally, today at 6:00 p.m. ET, San Francisco Fed President Mary Daly will discuss the current economic challenges faced by young Americans and opportunities to foster economic resilience at a town hall event hosted by the Chicago Council on Global Affairs.

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On Friday, nonfarm payrolls unexpectedly rose by 336k in September, nearly double the 170k gain expected according to?Bloomberg?and the strongest pace of job creation since January.

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Meanwhile, August payrolls were revised higher from a 187k gain to a 227k increase. With additional revisions to previous months, the?overall change in nonfarm payrolls (September data + net revisions) was 455k.

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Private payrolls rose by 263k in September following a 177k gain in August. Goods-producing payrolls rose by 29k due to an 11k rise in construction payrolls and a 17k gain in manufacturing payrolls. Private service producing payrolls rose by 234k in September, up from a 130k gain in August. Leisure and hospitality payrolls led the gain in service payrolls in September, rising 96k following a 44k rise the month prior. Also, education and health payrolls rose 70k, and trade and transport payrolls rose 45k at the end of Q3 due to a 20k gain in retail trade payrolls. Additionally, professional and business services payrolls rose 21k, despite a 4k drop in temporary help payrolls, and financial payrolls gained 3k. On the other hand, information payrolls declined 5k in September. Finally, government payrolls rose by 73k in September following a 50k gain in August.

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Household employment rose by 86k in September following a 222k increase the month prior. The labor force, meanwhile, rose by 90k following a 736k rise in August. Thus, the unemployment rate unexpectedly remained at 3.8% in September for the second consecutive month, matching the highest level of joblessness since February 2022. According to the median forecast, the unemployment rate was expected to decline to 3.7%.

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The labor force participation rate, meanwhile, remained at 62.8% in September, matching the highest rate since February 2020. At 62.8%, however, the participation rate is still below the pre-pandemic rate of?63.3%.

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Also, average hourly earnings rose 0.2% in September, a tenth of a percentage point less than expected and following a similar increase in August. Year-over-year, wages rose 4.2%, down from the 4.3% annual gain in August and the weakest gain since June 2021.

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Finally, the average workweek remained at 34.4 hours in September.

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Bottom Line: The labor market continues to exemplify tight conditions as hiring surged in the latest September report. Furthermore, as wages continue to accelerate, albeit at a slightly reduced pace, and the unemployment rate continues to bounce below the Fed’s full employment range, with inflation showing less improvement than previously anticipated relative to earlier forecasts, it’s clear the Committee still has more work to do. While the Fed need not continue to raise rates indefinitely or until both goals are explicitly met?in terms of full employment and stable prices, the ongoing challenges of inflation, including the sticky nature of labor costs, perpetuate the notion of even higher for even longer than expected.?

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The September Summary of Economic Projections (SEP) implied one further rate hike and 50bps of cuts in 2024. However, should inflation fail to maintain a clear disinflation path back towards 2%, the Committee could be forced to revise higher its expected level of the terminal rate and further reduce forecasts for rate cuts over the subsequent 15-18 months.??

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Meanwhile, amid the sentiment of higher for longer, coupled with a renewed focus on a?mounting debt burden and increasing costs to service the existing debt in a rising rate environment, longer-term yields remain elevated. In fact, many Street forecasts have been revised up, calling for a 5% or even 6% yield on the 10-year by the end of December.?

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While certainly fiscal woes give credence to a higher level of rates on the longer end, the – eventual – emerging weakness in the economy as businesses face ongoing pressures and consumers grapple with waning artificial support, should temper a rise to 5%. Nevertheless, it is clear a new normal has been established as investors wake up to the notion government spending cannot go unchecked and at some point debts must be repaid, and unfortunately in this case, at a markedly elevated cost.?

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Also on Friday, consumer credit unexpectedly dropped by $15.6b in August, the largest decline in three years, and a reflection of a drop in non-revolving credit tied to student loan forgiveness. According to the median forecast, consumer credit was expected to rise by $11.7b in August.

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Yesterday, the economic calendar was empty on Monday as the bond markets were closed for Columbus Day.

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This morning, the September NFIB Small Business Optimism Index declined from 91.3 to a reading of 90.8 in September, more than the expected decline to 91.0 and a four-month low.

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The key reports, however, come tomorrow and Thursday with the latest read of the September PPI and CPI.

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Tomorrow, the PPI is expected to rise 0.3% in September and 1.6% over the past 12 months, matching the annual gain in August. Excluding food and energy, the core PPI is expected to rise 0.2% in September and 2.3% year-over-year, up from the 2.2% gain the month prior.

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On Thursday, the CPI is expected to rise 0.3% in September and 3.6% over the past 12 months, down from the 3.7% annual gain in August. The core CPI is expected to rise 0.3% in September and 4.1% year-over-year, down from the 4.3% annual gain the month prior.

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Later in the week, on Friday, import and export price reports from September along with the preliminary October University of Michigan Consumer Sentiment Index report will be released.

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-Lindsey Piegza, Ph.D., Chief Economist