There is a significant risk that the Federal Open Market Committee (FOMC), the US Federal Reserve’s policymaking body, will unveil fewer than expected rate cuts next year, despite the overall resilience of the US economy and the still low unemployment rate.
This means that it is not a foregone conclusion that inflation will come down to 2.0% over the medium term and that interest rates are likely to remain higher for longer.
There is also a consensus among asset managers that the Fed will not announce an interest rate hike at the end of its meeting on September 20 (early Thursday in Hong Kong) and that it is nearing the end of its quantitative tightening cycle. (This expectation was met when US Fed chairman Jerome Powell announced that they were holding interest rates steady.)
There is, however, some apprehension that the FOMC may announce another rate hike during its meeting in December, depending on certain domestic developments that may negatively impact the US economy. (This expectation was also met when Powell indicated that there may be one more rate hike before the end of the year.)
“With regard to the November meeting, I think that the odds are still 50/50 even if market pricing has recently moved to price a lower probability,” says Blerina Uruci, chief US economist at T. Rowe Price. “The key risks to the November meeting decision are a possible government shutdown (as soon as October if a continuing resolution is not signed) and the United Auto Workers (UAW) strike. If these become protracted and lead to distortions in the near-term data, then the FOMC may build a case for inaction in November in light of heightened uncertainty. But a final hike could still be delivered in December.”
Uruci’s opinion was echoed by Ipek Ozkardeskaya, senior analyst at Swissquote Bank, who says the Fed will likely revise its growth expectations significantly higher on the back of resilient consumer spending and solid GDP growth.
“The looming talk of another government shutdown, the student loan repayments, and the UAW strikes will surely have a negative impact on US growth numbers, but US treasury secretary Janet Yellen defends the scenario of ‘soft landing’ as the labour market is still healthy, industrial output is rising, and inflation is coming down,” Ozkardeskaya says.
Risk to investors
US inflation jumped to 3.7% in August 2023 from 3% in the previous month, after plummeting from a high of 9.1% in June 2022. Unemployment also rose to 3.8% in August 2023 from 3.5% in July, after declining from 3.7% in May.
“Despite the latest softness in the jobs data, the US inflation figures last week surprised to the upside. A major part of disinflation since last summer was due to waning post-Covid supply issues that led to higher supply, hence slower price growth. But the improvement in supply could be coming to an end, and oil prices are rising,” says Ozkardeskaya.
Energy prices continue to rise as crude oil climbed for the third week and is expected to hit US$95 a barrel.
“Investors are focused on the prospect of a widening supply deficit in the fourth quarter after Saudi Arabia and Russia extended supply cuts. We continue to think energy prices can remain higher and this should help MLPs,” according to a note Global X ETFs issued on September 19. (Master Limited Partnerships are companies that engage in the exploration, development, processing, or transportation of natural resources.)
There is also consensus that equity markets in general are losing momentum and that the risk for investors, particularly in US equities, is skewed to the downside for the remainder of the year.
“The key point I'd make here is that the equity rally year-to-date has been entirely a function of earnings expansion,” says Sam Lynton-Brown, head of global macro strategy (rates, FX and commodities) at BNP Paribas. “What that means is the expectations for earnings haven't been going up. Prices have been going up, but not earnings. And in an environment where liquidity is contracting across developed markets, we shouldn't see earnings expand, we should see the contract multiple expand rather than contract.”