Slower Growth Expectations

Amid a number of challenges ranging from power shortages and supply chain disruptions to COVID-19 outbreaks, the Chinese economy slowed in the third quarter. The latest read on GDP showed the Chinese economy grew just 4.9% year-over-year, falling short of expectations for a 5.2% expansion. This marks the weakest clip since Q3 of 2020 and follows a 7.9% gain the quarter prior.

Expectations for U.S. growth have similarly slowed with the domestic economy facing its own lingering supply chain challenges and a still elevated level of COVID-19 case numbers. Following a 6.7% rise in Q2, the fastest pace since a 33.8% jump in Q3 2020, the economy is expected to slow to a 3.5% pace in the third quarter, according to?Bloomberg.

Despite a reduced growth outlook, rising inflation and a potential near-term reversal of accommodative monetary policy, equity investors remain optimistic. Despite three down sessions last week, the Dow ended the week higher, up 1.6%. This morning, however, equities are trading lower with the Dow down 0.53% at 34,983 as of 9:08 a.m. ET.

The 10-year rose 6bps on Friday to 1.57%, closing out the week, however, down 4bps. This morning, the 10-year is up 5bps, trading at 1.62% as of 9:10 a.m. ET.

On Friday, retail sales unexpectedly rose 0.7% in September. According to?Bloomberg, sales were expected to decline 0.2%. August sales, meanwhile, were revised up from a 0.7% gain to a 0.9% increase. Year-over-year, retail sales rose 13.9% in September, following a 15.4% annual increase in August.

Car sales rose 0.5% in September, following four consecutive months of decline, and gasoline stations sales rose 1.8% following a 1.0% increase the month prior. Excluding autos, retail sales rose 0.8% in September and rose 16.2% over the past 12 months. Excluding autos?and?gasoline, retail sales increased 0.7% and gained 13.5% year-over-year.

In the details, sporting goods sales jumped 3.7%, following five consecutive months of decline, and general merchandise sales gained 2.0%, thanks to a 0.9% rise in department store sales. Clothing sales rose 1.1%, eating and drinking sales gained 0.3%, and non-store retailer sales rose 0.6%. Also, furniture sales ticked up 0.2%, and building materials sales increased 0.1%. Additionally, food and beverage sales rose 0.7%, and miscellaneous sales increased 1.8% at the end of Q3. On the weaker side, health and personal care sales dropped 1.4%, and electronics sales declined 0.9%, the third consecutive month of decline.

Bottom Line:?As government stimulus tapers off, many feared demand would take a sizable hit, particularly as millions remain sidelined from the labor market. However, while spending remains volatile month to month and much reduced from a more robust pace in the first half, U.S. consumers are proving surprisingly resilient.

Against the backdrop of trillions in savings in good part reflecting arguably overly generous benefits for months replacing or in some cases exceeding one’s earnings potential in the private sector, coupled with a moratorium on evictions and the enhanced child tax credit, many have been able to accumulate a sizable wealth cushion. This cushion will not only carry many for some time negating the immediate need to return to work, but will continue to support positive spending patterns. That being said, rising prices are also contributing to a solid headline. Meaning, consumers are not just buying more but paying more for goods.

The question going forward, however, is first, how long will this savings last and will rising – and unchecked – inflation undermine savings faster than consumers anticipate? And second, what happens when the savings disappear? Will millions of Americans flood into the labor market or will policy makers offer further assistance to those reporting a position of unemployment? Either scenario will result in near-term relief and continue to foster spending. The former, however, will create a more organic, more sustainable situation, while the latter could perpetuate a labor supply shortage, further boost inflation and undermine the longer-run potential of the domestic economy.

Speaking of inflation, earlier last week the latest reads in prices showed the CPI rose 0.4% in September, more than the 0.3% increase expected and following a 0.3% gain in August. Year-over-year, consumer prices rose 5.4%, up from the 5.3% pace reported the month prior. Excluding food and energy costs, the core CPI rose 0.2%, as expected and following a 0.1% increase in August. Year-over-year, the core CPI increased 4.0% for the second consecutive month.

The PPI, meanwhile, rose 0.5% in September, a tenth of a percentage point less than the 0.6% gain expected and following a 0.7% rise the month prior. Year-over-year, however, producer prices jumped 8.6% in September, the largest gain on records dating back to 2010. Excluding food and energy costs, the core PPI rose 0.2%, less than the 0.5% rise expected, and following a 0.6% increase in August. Year-over-year, the core PPI increased 6.8%, also the largest gain on record.

Additionally on Wednesday of last week the September FOMC meeting minutes were released. According to the FOMC minutes, the majority of Fed officials?agreed?last month that it would be appropriate to begin to reduce the emergency measures put in place to combat domestic weakness as a result of the global pandemic.?Furthermore, according to the minutes, participants?indicated that if the Committee?reached a decision to initiate?taper at the next meeting, the process itself could begin before year-end.??

"Participants generally assessed that, provided that the economic recovery remained broadly on track, a gradual tapering process that concluded around the middle of next year would likely be appropriate. Participants noted that if a decision to begin tapering purchases occurred at the next meeting, the process of tapering could commence with the monthly purchase calendars beginning in either mid-November or mid-December.”

-????????September 22 FOMC Meeting Minutes

Recall, at the September FOMC press conference, Federal Reserve Chairman Jerome Powell opened the door for a near-term taper, indicating that the current progress, if sustained, could warrant a slower pace of accommodation. After all, according to Powell, as of last month, both sides of the Committee’s duel mandate, stable prices and full employment, had been met. He noted, however, opinions did vary among policy makers.?

Indeed, the September 22 FOMC meeting minutes indicated a fruitful discussion, particularly surrounding inflation, with a high degree of uncertainty and lingering risks to both sides. In their discussion of inflation, participants noted that inflation was elevated, and would likely remain elevated for some time before moderating. As a result, participants increased their inflation projections, accounting for larger-than-expected supply constraints in product and labor markets. Some participants did express concerns that elevated rates of inflation could feed through into longer-term inflation expectations, although others pointed to COVID-sensitive categories as bearing the brunt of the rise.?

Bottom Line:?Following a disappointing September payrolls number, there was concern the Fed would begin to walk back the September language clearly?setting the stage for a November/December taper launch.?The minutes, however, revealed a somewhat?solid consensus that at least step one in rolling back the Fed’s accommodative stance – initiating the taper – appears appropriate against the backdrop of solid improvement in the labor market and elevated inflation.?Thus, one subpar data point – a disappointing 194k September payrolls rise – should not?be enough to derail the Committee’s intention to move forward with a slower pace of asset purchases?sooner than later.??

That being said, a continued unevenness?in the?data could slow the pace of taper or extend the timeline for ending purchases.?According to the minutes, the?path featured was?monthly reductions by $10 billion in the case of Treasury securities and $5 billion in the case of agency mortgage-backed securities (MBS), already slower than many had anticipated.?At this pace,?if started?later this year, the Federal Reserve would end purchases mid-2022 at the earliest.??

This morning, industrial production unexpectedly dropped 1.3% in September, the largest monthly decline since February. According to?Bloomberg,?production was expected to rise 0.1% at the end of Q3. Year-over-year, production rose 4.6%, a six-month low.

Capacity utilization fell from 76.2% to 75.2% in September, a five-month low. According to?Bloomberg, capacity utilization was expected to rise to 76.4%.

Additionally, the NAHB Housing Market Index unexpectedly rose from 76 to a reading of 80 in October, a three-month high. According to?Bloomberg, the index was expected to decline to a reading of 75 at the start of Q4.

Tomorrow, housing starts are expected to remain flat, while building permits are expected to drop 2.4% in September.

Later this week, on Wednesday, the Federal Reserve will release its Beige Book.

And finally, on Thursday, initial jobless claims are expected to rise from 293k to 298k in the week ending October 16, and existing home sales are expected to rise 3.5% in September following a 2.0% drop in August.

-Lindsey Piegza, Ph.D., Chief Economist