by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Happy Halloween! Markets are currently digesting the latest inflation data as investors gauge the Federal Reserve’s next move. In sports news, the Los Angeles Dodgers clinched a World Series victory over the New York Yankees. Today’s Comment will delve into a detailed analysis of the recent GDP data, explore the challenges faced by Big Tech companies in scaling data center infrastructure to meet AI demands, and provide a brief overview of the UK’s recent budget. As always, the report will conclude with a roundup of international and domestic data releases.

GDP Resilience: The robust economic growth observed in the third quarter has complicated the Federal Reserve’s decision-making process regarding potential interest rate cuts.

• US GDP expanded at an annualized rate of 2.8% in the third quarter, marginally missing the projected 3.0%. Strong consumer spending and government expenditures were the primary growth drivers. Consumer spending accelerated from 2.8% to 3.7% annualized, led by a surge in nondurable goods purchases. Additionally, increased defense spending contributed nearly 20% to overall growth. However, investment, particularly residential spending, contracted from the previous quarter as elevated interest rates continue to act as a drag to economic output.
• While third-quarter growth was robust, its sustainability remains uncertain. Precautionary spending, likely driven by concerns over a potentially prolonged port worker strike on the East and Gulf Coasts, may have pulled forward much of the anticipated consumption for the coming quarter. Additionally, the surge in defense spending, largely driven by escalating tensions in Ukraine and the Middle East, may be a one-time event. Consequently, the latest report may still provide a complicated picture for the Fed when it is deciding whether it is appropriate to adjust policy rates.

• The Federal Reserve’s decision on whether to cut rates will likely hinge on Friday’s jobs report. In its previous meeting, the Fed revised its year-end unemployment rate expectation upward from 4.1% to 4.4%. Given that the unemployment rate has since declined from its 2024 peak of 4.3% to 4.1%, a significant rate cut this month is highly improbable. However, a pause in rate hikes remains a distinct possibility, especially if the unemployment rate continues its downward trend, given the recent strength of economic data.

Data Centers on the Rise: The limited supply of data centers is preventing tech companies from being able to capitalize on the rising demand for AI.

• Microsoft and Meta have recently warned that their limited data center capacity could hinder revenue growth in their cloud businesses. This outlook has dampened investor sentiment towards both companies, as it implies a need for increased capital expenditures to expand their infrastructure. Consequently, both companies experienced a decline in their share prices, despite reporting relatively strong revenue growth in the third quarter. Investors are concerned about the long-term profitability of these companies, given their consistently upward revised spending forecasts that have outpaced revenue guidance.
• Building out data center capacity has proven challenging, as construction projects have faced significant pushback from local communities. These communities often cite concerns about noise pollution, land use, and limited job creation. Many towns across the country have been reluctant to approve data center construction projects. Additionally, the energy intensity of these facilities has become a concern, as utility companies struggle to build out the necessary infrastructure to meet the demand. These challenges will limit tech companies’ ability to expand their data center capacity.

• While the demand for data centers continues to grow, the ability to build them at scale is facing significant challenges. This could hinder the growth of major tech companies as they seek to expand their infrastructure. Although this may not entirely derail revenue growth, it suggests that the path to profitability may be more arduous than many investors anticipate. Given that the future profitability of large tech companies is already largely priced into their stock prices, we believe investors may find more attractive opportunities in other sectors, particularly those with limited exposure to AI.

UK Budget: The Labour Party delivered its budget proposal to mixed fanfare.

• The new budget proposal aims to generate nearly $52 billion in additional tax revenue by the end of the decade. Over half of this revenue would come from an increase in the National Insurance payroll tax, with additional taxes levied on inheritance and capital gains. The budget also seeks to boost long-term growth through increased spending on infrastructure and research and development. While the market’s initial reaction was negative, it was far from a panic. On Wednesday, the 10-year UK gilt yield rose 18 basis points, and the pound sterling (GBP) modestly weakened by 0.4% against the US dollar.
• While the recent budget averted another “Liz Truss Moment,” it has raised concerns about the UK’s economic growth outlook for the coming quarters. The National Insurance payroll tax levy, in particular, has drawn significant criticism. A left-leaning think tank estimates that this tax increase will limit the real weekly wage to approximately $17 higher by the end of 2028, compared to two decades ago. However, this projection assumes that businesses will pass on the tax burden to consumers and workers to protect their profit margins.

• Governments worldwide are increasingly recognizing the need to generate additional tax revenue to offset pandemic-related spending. While some countries may be able to increase funding through robust economic growth, others, like the UK, may need to rely on higher taxes to balance their budgets. The recent UK budget proposal indicates that the government does not believe that growth alone will suffice to close the fiscal gap. While we expect the new proposal to have long-term benefits, we believe that long-term bonds could present an attractive investment opportunity if the plan is successful.

In Other News: Factory activity in China strengthened for the first time in six months, in a sign that the economy is starting to show signs of life. Volkswagen is demanding that its workers take a 10% pay cut as it looks to avoid having to make layoffs. North Korea conducted its longest ever ballistic missile test flight time in a sign that the country is looking to assert itself no matter who wins the US election in November.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is still processing the latest earnings data from Alphabet. In sports news, the New York Yankees managed to avoid being swept by the LA Dodgers. Today’s Comment will discuss why consumers remain content despite a cooling labor market. We will also review the latest earnings report from tech companies and explain why the EU is starting to get tough on trade. As usual, our report will include a roundup of international and domestic data releases.

The Job Market: As a precautionary measure against additional layoffs, employers are beginning to reduce the number of job postings.

• The Bureau of Labor Statistics reported a surprising decline in job openings to a three-year low in September. Last month, job postings fell from 7.861 million to 7.443 million, significantly below the consensus estimate of 7.990 million. Despite this decrease, the report also contained some positive news — hiring actually increased from 5.43 million to 5.55 million. The combination of fewer openings and an increase in hiring suggests that the labor market may be cooling but remains relatively tight.
• Even as job openings decline, consumers’ confidence in their job prospects has seen a significant uptick, reaching its highest point since March 2021. The Conference Board’s Consumer Confidence Index rose from 99.2 to 108.7, primarily fueled by consumers’ growing optimism about their present situation given the overall economy and the strength of the labor market. This positive sentiment is further underscored by the widening gap between those who perceive jobs as plentiful and those who believe jobs are scarce, a trend not observed since January.

• The data on job openings and consumer confidence aligns with our view of a resilient economy. While the decline in openings indicates cooling labor demand, it also reinforces our belief that firms are hesitant to lay off workers. This sentiment has likely translated into increased job security for consumers. However, a key question remains: How will this impact wage growth? If wages continue to rise above historical trends, it could exert upward pressure on inflation. Conversely, if wage growth moderates, it may alleviate price pressures and potentially prompt the Fed to ease monetary policy.

AI Is Back: After concerns about overspending on AI, Google’s parent company Alphabet demonstrated that its investments may be paying off.

• On Thursday, the tech giant exceeded expectations for both profit and revenue, driven by strong growth in its cloud business. The company has faced significant pressure due to concerns about excessive spending to compete with Microsoft following its partnership with OpenAI. Despite increased capital spending in the third quarter, Google’s cloud division saw a 35% growth in revenue year-over-year. Additionally, the company has been able to reduce the cost of its search engine business by over 90% in 18 months.
• Alphabet was the second of the Magnificent 7 companies, after Tesla, to report stronger-than-expected third-quarter earnings. This robust performance is likely to bolster investor optimism for the broader index further, as investors seek signs that mega-cap tech companies can sustain their momentum despite concerns about AI-related overspending that have plagued other companies within the index. While the Magnificent 7 index has surged nearly 50% year-to-date, Nvidia and Meta have been the primary drivers, accounting for over 60% of the gains.

• Alphabet’s strong performance bodes well for other mega-cap tech companies. Last quarter, Google, Microsoft, Meta, and Amazon increased their AI investments, betting on significant untapped demand for these services. Increased capital spending reflects their belief in the potential for future revenue growth. If other companies report similar sales growth this quarter, investors may take a closer look at the Magnificent 7 stocks, especially if interest rates rise. However, we believe that other non-tech sectors offer more long-term value.

European Protectionism: The EU has started to crack down on Chinese dumping as it looks to protect its own domestic industries.

• The EU will impose tariffs on Chinese electric vehicles (EV) on Thursday, as negotiations to resolve trade disputes between the two sides have failed. These tariffs aim to prevent China from dominating the region’s EV market. EU regulators have accused Beijing of unfair trade practices, such as providing substantial subsidies, which have allowed Chinese EVs to undercut prices of domestically produced cars. The rapid growth of Chinese EV sales is evident, increasing from a mere 3.9% of the market in 2020 to a significant 25% in 2023.
• The decision to impose tariffs comes as the West’s efforts to develop its own green technology industry have faced significant headwinds. The region has struggled to nurture domestic firms, unable to compete with the lower prices of Chinese imports or the generous incentives offered by the US to boost clean-tech manufacturing. For instance, since the passage of the Inflation Reduction Act, US solar investments have surged from $200 million to over $2 billion, while EU investments have declined to $141 million, despite starting from a similar level.

• The EU tariffs on Chinese electric vehicles sends a clear signal that the EU intends to bolster its domestic clean-tech industry. This move could also foreshadow potential retaliatory measures by the EU against the US if the next administration imposes tariffs on EU goods. While the EU may seek to retaliate, it is also likely to pressure the US to reduce tax incentives and subsidies for foreign firms building factories domestically. While a trade war between the US and EU may not be desirable for either party, it is something that could be an issue as it is unclear which side will back down.

In Other News: Israeli Prime Minister Benjamin Netanyahu has expressed interest in negotiating a short truce with Hamas. The German economy unexpectedly grew in the third quarter in a sign that the worst of the downturn may be behind it. Russia has fined Google $2.5 decillion for not allowing propaganda on its YouTube platform.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is currently awaiting the latest earnings reports from several mega-cap tech companies. In sports news, Rodri from Manchester City has been awarded the Ballon d’Or for the 2023/2024 season. Today’s Comment will address rising concerns about financing the US deficit, explore the efforts to increase restrictions on US investments in China, and provide an update on Russia’s use of North Korean troops in its war against Ukraine. As usual, our report will include a roundup of both international and domestic data releases.

Treasury Supply Unease: US bond yields have increased due to a disappointing Treasury auction and concerns about financing the federal deficit.

• The US Treasury Department forecasts borrowing $546 billion in the final quarter of the year, which is a $19 billion decrease from the previous quarter’s estimate. This projection assumes a year-end cash balance of $700 billion. While the decrease in borrowing was a welcome sign, markets are still grappling with how to absorb the substantial debt. Monday’s weak auctions for two- and five-year Treasurys underscore these worries as investors have started to price in the possibility of rising inflation expectations and less dovish Fed policy.
• Bond yields on Wednesday are expected to respond to the Treasury Department’s guidance on debt financing for the upcoming year. Investors anticipate that the quarterly refunding announcement will indicate a need for around $125 billion, consistent with May’s announcement, which maintained auction sizes for the next few quarters. With auction sizes at record highs — particularly for the 10-year Treasury — any increase above this level could drive yields higher, while a reduction might prompt a retreat. Additionally, a miss could further lead to a decline in US government bond liquidity.

• The nation’s debt remains a persistent challenge, as neither presidential candidate has offered a specific plan to tackle the deficit. Instead, their proposals rely on general and potentially contentious measures such as tax hikes and spending reductions. This absence of a clear fiscal strategy is anticipated to drive up bond yields. However, if inflation continues to moderate or the job market weakens, this upward pressure could diminish. Recent estimates from the Cleveland Fed suggest that core PCE inflation may stabilize in the near term, while unemployment rates are expected to remain at 4.1%.

Chip Wars: The White House has unveiled new restrictions on US investments in Chinese companies, aiming to curb the development of critical technologies that could potentially be used by the Chinese military.

• The new restrictions, set to take effect on January 2, will limit US investment in Chinese semiconductor and artificial intelligence companies. Additionally, investors will be required to report certain other forms of assistance to regulators. While the US has already imposed export controls on specific technologies, these new measures aim to prevent US investors from holding equity in companies with ties to the Chinese military. This move comes as a recent report revealed that American investors participated in 17% of global transactions involving Chinese AI companies.
• The restriction on US investments into China comes as Beijing looks to shore up its domestic industry. In recent years, China has aggressively sought to develop its domestic semiconductor industry through substantial investments and the acquisition of advanced manufacturing equipment. Simultaneously, China has imposed export controls on critical minerals essential for chip production, aiming to secure a reliable supply for its domestic industry and potentially limiting access for the US and other Western nations. Although China still trails the US in advanced chipmaking, it is steadily narrowing the gap.

• The escalating semiconductor rivalry is creating headwinds for US tech firms. Apple, for instance, is facing obstacles in launching Apple Intelligence in China due to stringent AI regulations. This could prompt other US AI companies to form partnerships with Chinese firms, despite increased US regulatory scrutiny. To mitigate supply chain risks, Apple has invested in India to diversify its manufacturing base. However, ongoing trade tensions remain a significant challenge for mega-cap tech companies, prompting investors to consider opportunities in other sectors.

The Korea Problem: The prospect of North Korean troops being deployed in Ukraine has raised the likelihood of a broadening war.

• The Pentagon estimates that over 10,000 North Korean troops have been deployed to Russia. While it remains unclear if these soldiers have engaged in combat, US intelligence indicates a significant presence in Russia’s embattled Kursk region, which borders Ukraine. In response to these reports, Ukraine has pressed Western allies to supply weapons capable of striking deep within Russia. Such a move, according to Russian President Vladimir Putin, would be seen as direct NATO involvement in the conflict.
• The potential involvement of North Korean troops in Russia’s war against Ukraine has raised serious concerns about further destabilizing Europe and could have broader implications for the Indo-Pacific region. Following these reports, there have been renewed calls for deploying EU troops to Ukraine. This idea, initially suggested by French President Emmanuel Macron, was previously rejected by German Chancellor Olaf Scholz. In response to the growing threat posed by North Korea, South Korea has agreed to share intelligence with NATO to coordinate a more effective response.

• The ongoing conflict in Ukraine underscores the increasing importance of military cooperation, even as geopolitical tensions drive global decoupling. Russia’s strengthened trade ties with Iran, North Korea, and China, coupled with Beijing’s increased export allocation to the region, have enabled these countries to mitigate the impact of Western sanctions. This growing economic and geopolitical alliance could lead to further collaboration on initiatives beyond Ukraine, potentially including actions on the Korean Peninsula or regarding Taiwan.

In Other News: US natural gas prices plummeted 11% on Monday, driven by expectations of warmer-than-usual autumn temperatures, increased domestic production, and easing geopolitical tensions. There is growing skepticism as to whether the Fed will be able to cut rates two more times this year as the economy proves to be very resilient in spite of elevated interest rates.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with the aftermath of Israel’s airstrikes on Iran over the weekend. The bottom line is that both countries are showing signs of restraint, which has reduced the risk of a broader regional conflict and therefore pushed global energy prices down so far today. We next review several other international and US developments with the potential to affect the financial markets today, including an electoral loss for Japan’s ruling party and a new US directive to focus on artificial intelligence in the military.

Israel-Iran: Over the weekend, Israel launched a large number of airstrikes against Iran to retaliate for Tehran’s big missile attack on October 1. However, all reports suggest both the Israelis and the Iranians are pulling their punches and trying to avoid escalating the conflict. For example, the Israelis only targeted military-related facilities, and reports say Tel Aviv secretly warned Iran of the upcoming strikes via intermediary countries. Meanwhile, Iranian officials have avoided dramatizing the strikes and took care not to threaten a near-term response.

• For now, it appears Israel and Iran will keep a lid on their confrontation. That should help reduce the risk of the conflict widening into a regional war. For example, if Israel would have attacked Iran’s oil or nuclear infrastructure, Tehran might well have retaliated by striking Saudi Arabia’s oil facilities, disrupting global energy supplies, and forcing Riyadh to strike back. So far today, global oil prices are down about 5.5%.
• Despite Israel’s discipline in the attacks over the weekend, they probably weren’t inconsequential. Some reporting suggests that by striking Iran’s missile production facilities, Israel has crimped Iran’s ability to produce new replacement missiles, which could discourage it from launching new large-scale attacks against Israel.

European Union: Reports today say automaker Volkswagen plans to shut at least three German plants, eliminate tens of thousands of jobs, and slash pay by 10%. In response, the company’s worker council has hinted that union workers might strike. The downsizing and labor woes reflect the firm’s struggles as it faces intense competition in China, slowing sales across other major markets, and a costly transition to making electric vehicles — challenges faced by auto companies across the EU.

France: Moody’s Ratings today affirmed France’s sovereign bond rating of Aa2 but cut its outlook from stable to negative. The lowered outlook reflects the splintered government’s likely inability to meaningfully cut its budget deficit in the near term. The move is consistent with other recent rating actions and economic forecast cuts by private economists. Nevertheless, the action today has had no apparent effect on the spread between French and German bonds.

United Kingdom: New data shows the fertility rate in England and Wales fell to just 1.44 births over the lifetime of the average woman in 2023, the lowest since record keeping began in 1938 and far below the 2.10 rate that is considered necessary for a stable population with no immigration. The new figure points to further population aging in the UK in the coming years, which will probably put upward pressure on government spending and debt.

Georgia: In national elections on Saturday, officials said the Caucasus country’s Russia-aligned ruling party Georgia Dream came in first with 54.2% of the vote. The results came amid multiple reports of voting irregularities and voter intimidation, following weeks of reported interference by Russia, which wants to keep the country from joining the European Union. The losing opposition parties have called for protests later today.

Japan: In national elections yesterday, the ruling Liberal Democratic Party and its much smaller coalition partner Komeito lost their parliamentary majority, winning just 215 of the 465 seats in the Diet. Since the result was much worse than anticipated for the ruling coalition, Prime Minister Ishiba is widely expected to resign in the coming days. Japan is therefore likely to enter a period of political instability, which we suspect will be negative in the short-term for Japan’s economy, stocks, and currency.

Chinese Rare Earths Industry: According to the New York Times, the last two foreign-owned rare earth refineries in China have been acquired by state-owned companies, giving Beijing even greater control over the exotic minerals that are key to technologies such as advanced semiconductors and electric vehicles. Beijing’s acquisition of the refineries comes as it also tightens restrictions on the export of gallium, germanium, antimony, and other rare earths.

• Most of the world’s commercially viable rare earth resources are in China and the rest of its geopolitical and economic bloc. Not only does that include reserves in the ground, but also production and refining capacity.
• Separately, a new report from Benchmark Mineral Intelligence warns that Chinese companies now control about two-thirds of the cobalt resources in the Democratic Republic of the Congo, which produces about 74% of the global cobalt supply. Cobalt is also a key mineral for the electrification of the global economy.
• As the US-China geopolitical rivalry intensifies over time, we continue to believe that China will increasingly weaponize its control over rare earths, cobalt, and other key mineral resources. By cutting off access to these minerals, Beijing would hope to crimp the West’s economy and drive up prices.

Chinese Demographics: New data from the Ministry of Education shows that the number of operating kindergartens in the country fell by 5.1% in 2023, while the number of enrolled students fell by 11.6%. That marks the third straight year of declining kindergarten enrollment, reflecting China’s low birthrate and the demographic threat to its economic growth going forward.

US Military: The Biden administration issued a directive late last week prioritizing defense-related artificial-intelligence projects. The directive illustrates how information processing and other advanced technologies are increasingly critical to maintaining US military dominance. The directive could also spur even greater government and industry investment in AI projects going forward.

US Immigration Policy: With just eight days to go until the elections and much of the presidential candidates’ rhetoric touching on immigration, the Los Angeles Times last week carried a useful primer on how former President Trump might approach his promise to deport millions of illegal immigrants if he were elected. The article highlights the legal and logistical challenges to mass deportation, as well as the risk that US citizens would be caught up in the program. Another risk could be a disruption to labor supply in certain industries.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is eagerly awaiting the latest University of Michigan survey data to assess consumer sentiment ahead of the election. In sports news, the New York Yankees are set to take on the Los Angeles Dodgers in the first game of the World Series. Today’s Comment will explore what the strong October Purchasing Managers’ Index (PMI) indicates about corporate earnings. Next, we will provide an update on US chip production, followed by a discussion of Canada’s new immigration policy. As usual, our report will conclude with a roundup of international and domestic data releases.

US Shows Resilience: The latest S&P Global survey suggests that the economy is off to a robust start this quarter, indicating the potential for stable earnings growth.

• The October flash index showed an increase in business activity, with the composite PMI rising from 54.0 to 54.3. The services sector remained a key driver of the economy, while manufacturing continued to lag. Notably, firms raised prices for goods and services at the slowest pace in nearly 4.5 years. However, the employment component pointed to a slowdown in hiring for the third consecutive month. Despite weakness in exports, firms saw a sharp increase in new business, driven largely by strong domestic demand.
• The strong PMI data is a positive indicator for S&P earnings. As the accompanying chart demonstrates, a correlation exists between rising PMI values and improving corporate profitability. This relationship is likely due to the survey’s comprehensive tracking of key business metrics, including new orders, input and output prices, inventory levels, and overall business activity, which provides a valuable snapshot of the operational health of firms. As a result, the PMI has often been a good indicator when tracking the momentum of future corporate earnings.

• While the sideways movement in the index suggests that the economy is solidly in expansion, it also signals that significant earnings growth is unlikely in the near term. Nonetheless, this environment favors high-quality stocks with strong profitability and low debt levels, as they are better positioned to deliver sustainable dividends to investors. However, as confidence in a soft landing strengthens and the Fed begins to lower interest rates, we anticipate investors becoming more willing to take on risk.

US Chip Power: Taiwan Semiconductor Manufacturing Co (TSMC) has achieved a significant milestone at its US-based facility, bringing the United States one step closer to domestic chip manufacturing capabilities.

• TSMC’s Arizona plant has surpassed expectations, achieving production yields 4% higher than comparable facilities in Taiwan. This achievement, accomplished despite overcoming challenges such as labor disputes and construction delays, is a promising sign for US semiconductor independence. As the primary chip provider for Nvidia and Apple, TSMC’s increased domestic production capacity strengthens the company’s case for further government support under the CHIPS and Science Act. The company is expected to receive $6.6 billion in grants under this legislation.
• The expansion of semiconductor manufacturing hubs is at its most robust level in nearly half a century. Investments in facilities dedicated to computer, electronics, and electrical manufacturing now account for nearly 60% of total US construction spending, a significant increase from the approximately 8% share observed a decade ago. The new facilities are expected to triple the US’s chipmaking capacity by 2032, elevating its market share from 10% to 14% of global chip production. As a result, the US is better suited to be able to meet its growing demand for chips as it looks to dominate the AI space.

• The development of domestic semiconductor fabrication plants is likely to continue for national security reasons, but their long-term viability may be a concern if firms cannot significantly reduce costs. It has been widely speculated that firms may rely heavily on automation in these new facilities to maintain profitability. However, this could lead to pushback from lawmakers who want firms receiving funding to increase hiring for manufacturing workers. While we do not currently see this as a significant issue, it could become a potential problem in the future.

Canada Immigration Crackdown: Although the increase in foreign workers has bolstered the country’s economy, concerns over the rising costs of living have prompted a reassessment of immigration policy.

• On Thursday, the country released its Immigration Levels Plan, which aims to reduce the number of permanent residents by 20% by 2025. The new restrictions will cap the number of immigrants, leading to a contraction in the overall population over the next two years. Moderate growth is expected to resume in the third year. This policy change comes amid a growing backlash against the country’s immigration policies, which have allowed over 2.35 million people to immigrate since mid-2022, roughly the population of Houston.
• The surge in immigration has contributed to economic overheating, with rental inflation being a particular concern. Despite moderation in other areas and a decline in overall inflation, rental inflation has continued to accelerate, rising over 8% in Q3 2024 from the previous year. However, immigration has also helped boost Canada’s economic growth to match that of the US, at just over 2% per year over the past decade. As a result, there is an expectation that the restrictions could also slow the overall economy.

• The economic impact of immigration restrictions will depend largely on their effect on labor productivity. A significant increase in the labor supply can sometimes lead firms to become less inclined to adopt new technologies and improve their processes, which could potentially offset some of the production gaps caused by labor shortages. However, we believe that Canadian financial assets may benefit from the potential boost to consumer sentiment and spending resulting from these restrictions. Therefore, we maintain a cautiously optimistic outlook for the country.

In Other News: Cleveland Fed President Beth Hammack has reiterated that the central bank has more work to do before declaring victory over inflation, further indicating that many Fed officials favor a gradual approach to interest rate cuts. Meanwhile, new home sales increased in September as prospective buyers took advantage of the drop in mortgage rates. Russian President Vladimir Putin’s ambiguous explanation for the presence of North Korean troops in Russia suggests that he may be using the additional manpower to demonstrate his willingness to escalate the conflict in Ukraine.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is currently processing new earnings data. In sports news, Barcelona convincingly defeated Bayern Munich in the Champions League this week. Today’s Comment will begin with our analysis of the latest Federal Reserve Beige Book. We will then share our thoughts on the housing market and provide an overview of why Brazil finds itself caught in the middle of the conflict between the US and China. As always, the report will conclude with a roundup of economic and domestic data releases.

Fed’s Beige Book: The latest survey of business contacts in the Fed’s twelve districts indicates that economic growth has begun to slow.

• The latest Fed Beige Book supports the central bank’s recent decision to pivot, as contacts indicate a slowing economy. Nearly all Fed districts reported no change in economic activity since the previous September survey. Weakness was most evident in the manufacturing sector, with agriculture also showing signs of decline. In relation to the Fed’s dual mandate, over half of the firms reported slight to moderate hiring growth, while most noted a moderation in selling prices. That said, despite the dim outlook from business contacts, Fed officials remain positive.
• On Monday, Federal Reserve officials expressed optimism about the economy’s resilience, suggesting a cautious approach to interest rate cuts. While some favored a gradual reduction, others indicated that rate cuts could continue even in a strong economy. The latest dot plot reflects this divergence, showing a median expectation of 50 basis points in cuts for the rest of the year, but with nearly half of the committee favoring a more modest 25 basis point reduction. This varying degree of policy accommodation is likely to complicate the Fed’s efforts to coordinate monetary policy.

• While the Fed Beige Book may have emboldened dovish committee members, we believe the timing of the next rate cut hinges on the labor market’s strength and the level of inflation. The upcoming jobs report is projected to show 135,000 jobs added in October, with the unemployment rate remaining at 4.1%. Stronger-than-expected job growth or a falling unemployment rate could lead officials to skip a rate cut at their November meeting. Moreover, a 0.4% month-over-month increase in the core PCE price index, may necessitate a reassessment of the easing cycle altogether.

Residential Market: It has been over a month since the Fed cut rates, and the housing market has not rebounded.

• US sales of existing homes dropped to a 14-year low in September, with a 1.0% decline bringing sales to a seasonally adjusted annual rate of 3.84 million units. The subdued demand is likely tied to elevated home prices, despite borrowing costs reaching their lowest level in two years. The average home price is now roughly 6.3 times the average income, up from five times a decade ago. While lower borrowing costs have made homes more attractive, the main beneficiaries have been existing homeowners refinancing their mortgages to lower rates.
• Many potential homebuyers remain on the sidelines, waiting for mortgage rates to drop further and offset high home prices. This stems from the belief that rates will decline, mirroring their sharp rise during the Federal Reserve’s tightening cycle. In the first year of rate hikes, mortgage rates jumped from 3.5% to a peak of 7.2%, driven largely by uncertainty over how aggressively the Fed would raise rates. For rates to fall significantly, the Fed must clearly indicate how far it plans to cut interest rates. This is why rates have stopped their descent following the Fed’s first rate cut.

• The uncertainty surrounding the neutral interest rate (estimated to be between 2.25% and 4.00% according to the latest economic projections), complicates the outlook for mortgage rates. Inflation expectations, particularly the concerns about whether inflation will sustainably fall below 2%, play a significant role in determining the long-run path of Fed policy. As a result, mortgage rates are unlikely to decline significantly in the coming months, even if the central bank begins to cut rates. This could weigh on consumer sentiment and residential investment, hindering economic growth.

Brazil-China: Latin America’s largest economy appears to be under pressure to take sides in the US-China rift.

• On Wednesday, a US official urged Brazil to reconsider its plans to join China’s Belt and Road Initiative (BRI), cautioning that the agreement might not serve Brazil’s best interests as it could lead to a loss of sovereignty. This warning came in response to Brazil’s statements about potentially joining the initiative to counter protectionist measures from the US and the European Union. China remains one of Brazil’s top trading partners, while the US is one of the biggest contributors of foreign direct investment.
• The escalating dispute underscores growing concerns about the diminishing interconnectedness of the global economy. The West’s deliberate effort to reduce its role as the importer of last resort has prompted countries in the Global South to seek alternatives. Many are diversifying their currency reserves, including gold, and some are exploring regional currencies tied to their key commodities. This trend suggests that these countries are increasingly looking to offset the loss of trade with the West by trading with one another.

• As countries like Brazil navigate a less globalized world, we believe they will increasingly move away from using the US dollar. This shift is driven not only by the recent weaponization of the dollar but also by the desire to strengthen ties with other nations. In particular, countries aligned with China are likely to explore alternative currencies for trade as they reduce their reliance on the US. Although we don’t expect the dollar to lose its dominance, its influence may diminish over the next decade.

In Other News: The Bank of Canada cut its benchmark rate by 50 basis points, reflecting the global shift towards disinflation as it aims to normalize policy and shield Canada’s economy from further decline. Boeing workers voted against the latest wage agreement, likely setting the stage for an extended strike. Additionally, Tesla’s earnings report exceeded expectations, indicating that the worst may be over for the company.

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