Daily Comment (December 7, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! Risk assets are enjoying a lift as investors eagerly await tomorrow’s crucial jobs data. Meanwhile, former Padres’ outfielder Juan Soto is making his way to the Big Apple for his next adventure. Today’s Comment kicks off with our insights on the anticipated rate cuts for next year, then explores why banks are wary of the new Basel regulations, and finally delves into how China’s economic struggles might ultimately benefit the rest of the world. As always, our comprehensive report encompasses the latest domestic and international data releases.

Are Rate Cut Bets Overdone? Investors are having second thoughts on how aggressive the Fed will be when cutting rates next year.

  • Although inflation remains significantly above the Federal Reserve’s 2% target, it is still too early to predict with certainty whether the Fed will cut rates or stand pat next year. Furthermore, aggressive cuts, as anticipated by the market, are highly unlikely without a major economic crisis. The Atlanta Fed’s latest forecast projects a modest 1.3% annualized growth for the final quarter of 2023. Therefore, if we assume there will be no recession or perhaps a mild one, then any potential rate cuts in the coming year will likely be moderate.

Wall Street Woes: CEOs from major banks gathered on Capitol Hill to express their concerns about new financial regulations.

  • Implementation of new banking standards dubbed the “Basel III Endgame,” which are due to take effect in 2028, was the central topic of discussion. The chief executives argued that the proposed changes, which have not been finalized, are likely more burdensome than regulators realize. For example, the new capital requirements could make it harder for financial institutions to lend to households and small businesses, particularly those who already struggle to access credit. Additionally, the executives argued that the changes could push lending into less regulated sectors of the financial system. The banks’ concerns about the impact of the new regulations on lending come amid a significant rise in private credit lending, which has seen a dramatic increase in recent months.
  • The new rules were announced in July in response to growing concerns about the weakness within the financial system. These rules will apply to banks with holding over $100 billion in assets, exempting smaller institutions. The aim is to compel banks to adopt a more conservative and standardized approach to risk measurement, effectively requiring them to hold more capital as a buffer against losses. Regulators estimate a 19% average capital increase for globally systemically important banks (G-Sibs), although industry groups believe the actual increase could be significantly higher. Nevertheless, the stricter rules should help bring U.S. banks into compliance with international standards.

China Needs a Break: The country faces a growing number of obstacles as it seeks to expand its global reach and revitalize its struggling economy.

  • The country’s escalating economic problems will likely discourage Beijing from seeking major disruptions in its international relations in the near term. This is evidenced by Xi Jinping’s recent efforts to foster warmer ties with the United States, despite President Biden’s earlier remarks referring to him as a dictator. As the government seeks to manage its debt burden, promoting exports becomes an increasingly important strategy for generating growth and maintaining industrial production levels. This explains Xi Jinping’s recent trip to the EU, where he aimed to convince lawmakers not to place barriers on trade. In all, China’s shortcomings may lead to more stability as it may be too distracted to start a fight with the West.

Other News: Venezuelan President Nicolás Maduro recently unveiled a controversial map claiming Guyana’s Essequibo region as part of Venezuela. This action marks a significant escalation in Maduro’s ongoing efforts to assert control over the eastern region. President Biden suggested that there are Democrats who could possibly defeat Trump in an election, a possible sign that he may be weighing his options. Meanwhile, the Senate’s failure to pass legislation funding Ukraine due to demands for increased aid for U.S. border security highlights a growing trend of inward-focused politics as the nation grapples with its changing role in the global landscape.

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