The Core PCE Index increased by a mere 0.13% in August. This is only an annual gain of 2.1%. Super core (core services excluding housing inflation) increased by 0.16%. If inflation continues to behave, the Federal Reserve will have indeed achieved a perfect “Goldilocks” balance. Tame inflation numbers show that supply chain imbalance during COVID and pressures of the Russia-Ukraine war are easing off.
The good news continues with the U.S. economy expanding by 3%. But that growth does not reconcile with the slowdown in employment. The job market has seen big declines in the past two months. This mismatch means one of two things: either the job market is going to pick up to match the economy, or the economy is going to slow down to match employment. Remember that monetary policy works with a lag; we reminded readers about this lag during the hiking cycle. We think that the Fed’s rate-cutting should stimulate the economy and the job market with it. The boost in economic growth and the job market will catch up but with a lag effect.
The FOMC forecast of a neutral rate is just under 3%. We think that incoming data will dictate how the Federal Reserve navigates this rate-cutting cycle. For now, with a slowdown in inflation and good growth numbers, the Fed looks to follow a steady path of gradual rate cuts.
CHANGES IN RATES
Treasury yields increased slightly.
The money market continues to yield less. This new addition to our commentary highlights the decline of money market rates. Below, you will see that fund flows in the money market continue to rise. This shows that money market rates, while decreasing, are still the preferable option for cash.
The municipal curve moved marginally last week.
The muni-Treasury ratio looks marginally better because of Treasury yields lowering for the week.
Corporate yields were mixed last week.
The conflict between Israel and Hamas continues to intensify, with recent escalations leading to Israel striking central Beirut and killing Hezbollah’s leader, Hassan Nasrallah. In light of global tensions, Treasuries ended Friday with a flight to quality trade.
Closer to home, we’re watching a development out of California with the possible regulation of artificial intelligence. Governor Gavin Newsom vetoed a bill that would require developers of artificial intelligence models to reduce the chances that their models would be misused to create “critical harm.” The governor called this bill “well-intentioned” but flawed and said, “the bill could stifle innovation and prompt AI developers to move out of the state.” This is interesting because legislating AI will be challenging, but this appears to be a start.
Tomorrow is the first and only scheduled VP debate. The two running mates spent time last week campaigning in the battleground states of Pennsylvania and Michigan. We’ll be tuning in for what many expect to be a lively and potentially impactful performance. Here is something to celebrate - only 36 more days of the pre-election news cycle!
The 5-year Breakeven Inflation Rate finished the week of September 27 at 2.27%, 25 basis points higher than the close of September 20. The 10-year breakeven inflation rate finished the week at 2.15%, the same as September 20.
As of September 27, 10-year quality spreads (AAA vs. BBB) were 1.10%, sixteen basis points higher than the September 20 reading (based on our calculations). The long-term average is 1.70%.
Quality spreads in the taxable market are not attractive. They ended the week at 0.90%, one basis point higher than the week prior. High-yield quality spreads were the same at 2.96%.
Money Market Flows (millions of dollars)
Money market funds saw cash inflows.
Mutual Fund Flows (millions of dollars)
While up from the prior week, this was a week of net outflows for taxable mutual funds overall.
ETF Fund Flows (millions of dollars)
ETF asset classes all experienced decreased flows.
The supply of new issues is expected to be about $10.5 billion this week after last week’s elevated supply.
The Federal Reserve has achieved its “Goldilocks” scenario… for now. With inflation slowing down and the economy still growing at a 3% rate, they have struck a perfect balance for their rate-cutting cycle.
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