Daily Comment (August 31, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment has three main themes: 1) Why markets are rethinking expectations that the U.S. was in recovery; 2) How regulators are looking to rein in banks with new regulations; and 3) How El Niño may be a problem for the rest of the world but could lead to lower energy costs in the U.S.

 Optimism Fading:  Data continues to show a mixed picture of the current state of the economy.

  • Revision to the gross domestic product (GDP) and a release of private payroll information suggest that the economic activity is slowing. According to the Bureau of Economic Analysis, the economy expanded at an annual rate of 2.1% in Q2 2023, slower than the 2.4% in the previous report. On the same day, ADP private payrolls showed that the economy added 177k jobs in August, significantly lower than the previous month’s revised reading of 371k. The disappointing data has challenged the assumption that the worst is behind us and has raised hopes that the Federal Reserve will pause in September.
  • Investors welcomed the report, with many dreaming of a possible end to the rate-hiking cycle. The S&P 500 closed higher on Wednesday, while the yield on the 10-year Treasury fell to a three-week low. This shift in sentiment comes a day ahead of the release of the BLS payrolls report. If the report shows another setback in job growth, it will likely strengthen expectations that the Federal Reserve is done raising rates. The latest CME FedWatch Tool suggests that the FOMC is 90% likely to hold rates in September, and there is a nearly 60% chance of rates rising before the end of the year.

(Source: CME Group)

  • The economic outlook is becoming increasingly uncertain and complex. While it was widely expected that rapidly rising interest rates would hinder GDP growth, the fiscal and monetary response has altered this dynamic. Stimulus checks helped households pay down debt, while easy monetary policy allowed consumers to extend maturities and improve balance sheets. President Biden’s Inflation Reduction Act and infrastructure bills are also likely to mitigate the economic impact of tighter monetary policy. As a result, we are becoming more optimistic that the economy may be able to narrowly avoid a recession in 2023. This may also mean that the Fed may be persuaded to maintain tighter policy for longer.

Policing Banks: Lawmakers and regulators are tightening regulations on banks in an effort to mitigate the risk of future economic disruptions.

Weather Worries: El Niño could cause disruptions in some parts of the world, but its impact on the U.S. may be less severe.

  • In the U.S., El Niño conditions in the summer are typically weak, but it can cause wetter and warmer conditions in the South and drier conditions in the North. As El Niño strengthens, it is possible that these effects could become more pronounced. The prospect of a stronger El Niño has so far led to lower gas prices, as households are likely to use less energy as a result. This could weigh on inflation in the U.S. and could lead the Fed to follow through on its pause in interest rate hikes.

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