Volatility Cocktail

Putting it all together

• Looking past November is like peering into a thick fog. Things we know:
  • Between now and the election the Fed will be cutting rates.
  • The economy is currently humming along at or above potential growth.
  • There are signs that the labor markets are deteriorating faster than the Fed was anticipating, while disinflationary forces seem rooted, allowing the Fed to lean dovish.
• Things we don’t know:
  • The Fed’s forecast past election. This is because depending on who wins the election, Federal Reserve Policy may need to be very different.
• This dynamic has created a very short-sighted Fed, who continues to focus on the next piece of data being released rather than venturing to put forward a forecast, creating the potential for extreme bouts of volatility surrounded economic data releases.
• We remain constructive on risk-assets but are becoming more guarded based on deteriorating labor markets, stretched consumer and potential for election uncertainty sending money to the sidelines to wait out the outcome. Compounding our increased attentiveness to risk are seasonal patterns which indicate we are entering the most tricky time of the year.

Reviewing the Fed’s yardstick

• The Fed updates their Summary of Economic Projections four times a year. The last update was in June, when they projected at the end of 2024 the Unemployment Rate was going to be 4.0% and Core PCE was going to be 2.6%. The two combining to result in a Fed Funds Rate of 5.1%. With the release of Friday’s Core PCE, we are now are at the projection Core PCE at yearend and +0.3% over on the Unemployment Rate, which is above their peak 2025 projection and for the cycle.
• If we were to hold the Fed to their projections, the appropriate Fed Funds rate today would be somewhere significantly south of 5.1%, suggesting rates should be moving lower, likely by 50 basis point in September.
• Because PCE can be mostly constructed using components of CPI and PPI released earlier in the month, no one was surprised to see the PCE level. However, what was surprising was consumer spending and consumption data released that indicated Q3 is on track to print above potential GDP.

AI trend alive, well and maturing

• The markets went to the doctor and had a check-up on the AI story on Wednesday night when Nvidia reported. Although Nvidia beat numbers across the board, the paltry 122% growth over the last year was not enough to satisfy investor lusts, who have gotten used to seeing over 200% year-over-year growth reported each quarter.
• Despite the muted market response to Nvidia’s earnings, the projections for growth for AI infrastructure continues to be insatiable, all be at a slower pace. According to S&P Global:
  • Global AI spending will grow nearly 30% a year through 2028. Between now and then, AI spending will grow from 6% of global IT spending to 14% of global IT spending.
  • Hyperscaler spending on AI equipment was recently revised from roughly 30% a year to over 40% a year.
• With increased competition and the hyperscalers working to create chipsets of their own, it’s inevitable that Nvidia’s torrid pace of growth will slow, but the expansion of the AI movement is nothing short of alive and well.

Two-thirds the way through Q3

• Looking at the four GDP Nowcast measures we follow as signals of coincident indicators, there are few signs of a recession in Q3. Two-thirds of the way through Q3 GDP Nowcast models are consistent and all show above potential growth:
  • Atlanta Fed +2.5%
  • New York Fed +2.5%
  • St. Louis Fed +2.1%
  • Bloomberg +2.5%
• GDP Nowcast model are far from perfect. For example, the average difference in actual GDP versus average projections of the four models over the last four quarters underestimated the GDP growth rate by 1.0%.
• The Conference Board Coincident Composite and Dallas Fed Weekly Economic Index are two other measurement of real-time activity that also indicate above trend potential growth.

Housing Market Fatigue

• Pending Home Sales fell last month to an all-time low, while inventory continued to climb and is now at its highest levels since 2020, with active listings up 36.6% year-over-year.
• Active listings are now about 900k, which is off the low in 2022 of about 350k, but still well below the average level in the three years prior to the pandemic, where active listings averaged about 1.2m this time of the year.
• The combination of weak pending home sales and rising inventories is beginning to indicate over supply setting up lower prices, but there is a wildcard – pent-up demand.
• There is tight relationship between Pending Home Sales and mortgage rates. Mortgage rates have already backed off highs near 8.0% to 6.8%. As rates went up, the real deterioration in demand picked up around 5.5%, so we anticipate that demand will start to build again if rates fall below 6.0%, which looks like could happen by mid-2025.

Focus Point LMI Update

• The Focus Point Leading Market Indicator continued to point towards Neutral Conditions for the month of September.
• Important highlights from the Indicator internals include:
  • Improving liquidity conditions as Bank Credit of All Commercial Banks, a data series published in the Federal Reserves H8 release, showed momentum in bank lending that began in June.
  • The Fed telegraphing that interest rates will begin easing, reflects positively in our Liquidity indicator.
    Weakness in the manufacturing sector is intensifying with softness in Durable Goods Orders, Capex Orders and ISM Manufacturing data.

Unpacking relationships between personal income, spending and savings

• Last week’s release of Personal Income and Personal Spending combines with trends in Savings to paint a potentially negative story.
• Personal Income is up about 3.5% in the last 16 months, while at the same time Personal Spending is up a little over 4.5%.
  The difference means spending is out pacing income growth. The deficit is coming out of savings.
• Savings as a Percent of Disposable Income has fallen in the last 16 months by over 2.0% and is now approaching the post-pandemic lows that were supported by government transfer payments in June of 2022.
• Rising delinquencies tangentially point to rising spending and falling savings taking a toll on consumers. The $64 thousand question is how much longer this dynamic can persist without paying the piper?

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