by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is currently digesting the latest inflation data as it tries to gauge the Fed’s next move. In sports news, the New York Yankees clinched the AL East title for the second time in three years. Today’s Comment will dive into why chip companies are regaining popularity. We also give our thoughts on why interest rate benchmarks are important to the Fed and explain the impact that China’s stimulus will have on its economy. As usual, the report will end with a roundup of international and domestic data releases.

Chips Are Back: Chipmakers received a boost after Micron Technology’s results challenged the notion that the AI rally was fading.

• The US chipmaker announced a 93% year-over-year increase in its earnings for the fiscal year ending August 29. Moreover, the company revised its outlook for future revenue upward, indicating growing optimism about its growth potential in the AI sector. Following the results, the CEO credited the company’s strong performance to high demand for AI-related products. The impressive earnings and guidance sparked a post-earnings rally — the company’s largest since 2011. This positive news also boosted chipmakers broadly, pushing the PHLX Semiconductor Index up 3.5% on Thursday.
• Despite ongoing concerns about valuations in the AI sector, there is clear evidence of continued strong demand for AI technology. Major tech companies like Google, Meta, and Amazon are investing heavily in AI to establish a dominant position in the market. Meanwhile, demand for related products, such as smartphones and personal computers, has led to concerns about a possible chip shortage. Research from Bain Capital suggests that a modest 20% increase in demand could potentially disrupt supply.

• Despite the potential for a decline in current AI hype, we foresee that the underlying demand for AI products will ultimately benefit tech companies. While long-term concerns may emerge, they are unlikely to eclipse the inflated expectations surrounding the technology’s future applications. One of the primary concerns within the AI sector is valuation, as chip and other AI-related stocks still appear overvalued compared to other sectors. Consequently, we anticipate that some of the larger, highly valued companies in the space may experience continued growth, but the momentum is likely to moderate.

After LIBOR: Despite it being over a year since the shift from London Interbank Overnight Rate (LIBOR) to Secured Overnight Financing Rate (SOFR), Federal Reserve officials remain concerned about potential oversights.

• New York Fed President John Williams announced the establishment of a group of private market participants to oversee the use of interest rate benchmarks across financial markets. The decision comes amid ongoing concerns about the transition from LIBOR to SOFR and its potential impact on interbank lending. Although SOFR has served as a viable replacement for LIBOR, its lack of a component measuring bank funding costs has hindered the central bank’s ability to identify risks within the financial market and compromised its capacity to ensure financial stability.
• Increased oversight of reference rates is crucial as the central bank navigates its quantitative tightening program, which aims to shift the central bank’s balance sheet from “abundant” to “ample” reserves. Despite the lack of a definitive benchmark for optimal reserve levels, a previous attempt to reduce reserves resulted in a repo market crisis in 2019. Overnight repo rates skyrocketed due to an excess of Treasury securities and insufficient cash, forcing the central bank to prematurely halt its balance sheet reduction and lower policy rates.

• The establishment of a reference-rate-use committee might indicate that the Federal Reserve is nearing the conclusion of its quantitative tightening policy. The central bank began decelerating its balance sheet reduction in June, aiming to prolong this process for as long as feasible. While a complete cessation of tightening this year seems improbable, 2025 could offer a potential timeline. The end of quantitative tightening may place downward pressure on long-term bond yields, as the Fed would then be able to reinvest some of its holdings and absorb more of the Treasury market supply.

China Brings Out the Bazooka: To counter speculation about its willingness to employ all available economic tools, Beijing announced a new round of stimulus measures.

• On Thursday, the Politburo announced its intention to employ fiscal measures to revitalize the economy and bolster the struggling property sector. Although no official figure was disclosed, Reuters reported a planned issuance of $284 billion in sovereign debt. To complement increased spending, Beijing also expressed support for measured risk-taking. Under its “three E” policy, the country would grant immunity to individuals who make mistakes due to inexperience, experimentation, or unintentional errors while striving to promote development.
• The shift in policy may be attributed to concerns that the economy was on track to fall short of its growth target. Earlier this month, several investment banks lowered their growth projections for China following the weaker-than-expected second-quarter GDP growth of 4.7% year-over-year. More recent data also reinforces the view that the economy is in trouble. China’s National Bureau of Statistics reported that industrial profits experienced the most significant decline this year, accompanied by a slowdown in overall earnings. The cited cause of this weakness was insufficient market demand.

• The additional stimulus should provide investors with confidence that China is willing to pull out all the stops to revive the economy. However, it is unclear whether this will be enough to overcome the challenges known as the five Ds: weak consumer demand, excess capacity and high debt, poor demographics, economic disincentives from the Communist Party’s intervention in the markets, and Western decoupling from trade, technology and capital flows. Although we anticipate short-term improvements in Chinese and European equities, we will closely monitor their long-term performance.

In Other News: President Trump has announced that he is meeting with Ukrainian president Volodymyr Zelensky. The meeting will likely go over how Zelensky plans to end the conflict. China’s nuclear-powered submarine sank, which will likely foster doubts about the country’s military advancements. Shigeru Ishiba will become Japan’s next prime minister after winning the presidency of the ruling Liberal Democratic Party.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Financial markets are reacting to more stimulus news from China. In sports news, the Connecticut Sun clinched a dominant sweep over the Indiana Fever, securing their place in the WNBA semifinals. Today’s Comment will delve into the recent shake-up at OpenAI, explore the potential limitations that the Federal Reserve rate cuts will have on the housing market resurgence, and provide an update on the ongoing conflict in Israel. As always, we’ll conclude with a roundup of key international and domestic data releases.

OpenAI Goes Mainstream: The brawl over the direction of the firm has taken a new turn as the company looks to take its product global.

• The developer of ChatGPT is seeking to transform from a nonprofit to a for-profit entity in order to attract greater investor interest. As part of this transition, the company is offering its current nonprofit board a reduced role in exchange for a minority stake. Following the announcement of this shift, the company’s CTO, Mira Murati, and two other executives have resigned. Furthermore, the company’s CEO, Sam Altman, is anticipated to receive a 7% stake upon completion of the transition. The shake-up of the company’s leadership is a signal that the company is likely to alter its governance regarding AI risks.
• Since extending its partnership with Microsoft in early 2023, OpenAI has sought to integrate its technology into the global infrastructure. Altman has embarked on a world tour to encourage countries to expand their chip manufacturing facilities and data centers to facilitate the development of more powerful AI. He has even likened data centers to the essential nature of electricity. Despite the company’s growing fame, its expenses have outpaced its income, leading to speculation that it might seek a public offering.

• The escalating prominence of OpenAI is anticipated to bolster the sentiment surrounding tech companies and reinforce the belief that AI technology is a permanent fixture. However, a growing concern is the increasing resistance from labor unions and workers against the widespread adoption of automation and AI as a means to replace human workers. While there is a burgeoning momentum to expand the integration of this technology, investors should be prepared for potential public backlash in response to these concerns regarding worker displacement.

The Housing Market Shrugs: While there has been optimism that a lower policy rate could boost housing demand, we suspect that accommodative policy will have a more mixed impact.

• The Fed’s recent jumbo rate cut had a negligible effect on the mortgage market last week. According to the Mortgage Bankers Association, the average 30-year fixed mortgage rate fell by only 2 basis points from 6.16% to 6.14%. While loan applications experienced a surge, the majority of this increase was attributable to refinancing activity as homeowners sought to tap into their home equity. Although it’s too early to gauge the full impact of the rate cut on the housing market, there’s reason to believe that it may not provide the anticipated boost to home prices to which we have become accustomed.
• One reason for our doubts is the uncertainty over whether interest rates influence demand or supply more. Lower borrowing costs typically make it easier for homebuyers to secure loans, which, in theory, should drive up home prices. However, reduced rates also benefit homebuilders by lowering their costs. As shown in the chart below, a drop in the fed funds rate correlates with faster construction times for new homes, suggesting that lower rates could increase supply by bringing more homes to the market.

• Given the Fed’s decision to cut rates during a period of continued economic expansion, the overall stimulative impact may be less pronounced than in previous easing cycles. The limited impact can be partly attributed to the fact that rate cuts have not been fully transmitted to the longer end of the yield curve. This lack of transmission is unlikely to result in mortgage rates falling to a level that significantly attracts homebuyers, but it could make it easier for homebuilders to finance new projects. Consequently, we suspect that home price increases could begin to slow down over the next few months.

Tensions in the Middle East: Israel is preparing for a potential invasion of Lebanon to counter Hezbollah’s aggression; however, the oil market remains unaffected.

• Israel’s decision to prepare for escalation follows the Israeli air defense’s interception of a Hezbollah ballistic missile aimed at Tel Aviv. This comes after Israel warned its northern border troops that the ongoing airstrikes are meant to pave the way for a possible ground invasion. Meanwhile, US and French envoys are pushing for negotiations to broker a ceasefire and prevent a broader regional conflict, with hopes of reaching a peace agreement that could end the fighting in Gaza as well. While there remains optimism that tensions will calm, the prospect of war remains elevated.
• Despite historical links between Middle Eastern conflicts and higher oil prices, current supply dynamics seem to be preventing such a correlation. Saudi Arabia’s recent announcement that it is abandoning its unofficial $100/barrel price target suggests a strategic shift. By seeking to lower prices, the Kingdom aims to increase its market share, potentially foreshadowing another price war with US shale producers. Although the implementation of this strategy is not anticipated until December, the declaration indicates Saudi Arabia’s preparedness for such a confrontation.

• An Israeli invasion of Lebanon would likely put upward pressure on oil prices, although the precise magnitude of this increase remains uncertain. A crucial factor influencing the situation is Iran’s potential response. If Iran were to blockade the Strait of Hormuz, a vital oil shipping route, crude prices could surge dramatically. However, given Iran’s recent willingness to resume nuclear negotiations with the US, the likelihood of such a blockade appears to be low. In the near term, anticipated increases in oil production by OPEC countries could help mitigate some upward pressure on prices related to conflict.

In Other News: The Chinese Politburo has committed to implementing another round of stimulus measures, signaling its determination to reignite the faltering economy. Over six years since the Brexit vote, the European Union and the United Kingdom have seemingly rekindled open dialogue, as the two sides look to reset ties. Micron’s better-than-anticipated quarterly results suggest that AI-related stocks may still possess upward momentum.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Global markets are closely monitoring the impact of China’s recent stimulus measures. In sports news, the New York Liberty have taken a commanding lead over the Atlanta Dream in the first round of the WNBA playoffs. Today’s Comment will delve into why the Federal Reserve’s rate cut has failed to inspire market confidence in a soft economic landing, how India’s actions have been driving up silver prices, and the potential consequences of the Argentine president’s declining popularity due to his economic reforms. As usual, this report will conclude with a review of domestic and international data releases.

Market Not Convinced: Despite the Fed’s rate cut that was aimed at fostering a soft landing, concerns persist about the ongoing need to tame inflation.

• The Federal Reserve’s unexpected 50 basis point interest rate cut last week continues to move markets, as investors are uncertain about the path of future policy. There was a bear steepening of the yield curve following the cut, with long-term interest rates rising rather than falling. This unexpected move fueled concerns that the Fed may be declaring victory prematurely. These fears were echoed by Federal Reserve Governor Michelle Bowman, who dissented from the rate cut, advocating for a more measured approach to monetary policy.
• Despite the Fed’s efforts to stimulate a soft landing, the labor market remains a growing concern. The September Consumer Confidence Index plummeted to 98.7 from 124.3, marking its sharpest decline in three years. This downturn was primarily driven by rising anxieties about the job market, with fewer respondents perceiving it as plentiful and more reporting difficulty in finding employment. While these labor market indicators have deteriorated, consumer optimism about the overall business cycle persists, largely due to the expectation of lower interest rates.

• The lack of downward movement in long-term interest rates could have a negative impact on the economy but may also provide the Federal Reserve with room for further monetary easing. As Dallas Fed President Lorie Logan suggested last October, higher term premiums could be used as a justification for less restrictive monetary policy. If inflation continues to decline and the labor market shows signs of cooling, this strategy may become more likely. While we don’t anticipate another large rate cut, it’s not entirely out of the question if economic data continues to follow current trends.

Silver on the Rise: While China has been a major buyer of gold, India has been steadily accumulating silver.

• India’s silver imports are skyrocketing, driven by a combination of cultural tradition and industrial growth. The recent reduction in trade duties has further fueled India’s longstanding demand for silver, particularly during the lead-up to Diwali. Additionally, the drop in duties has amplified the country’s expanding solar panel and electronics industries as India looks to compete as a manufacturing power. Despite China’s dominance in solar cell manufacturing, India’s share of US imports has surged from less than 1% six years ago to nearly 11% in the second quarter of 2024.
• The escalating demand for silver, driven by countries’ intensified efforts to expand solar cell production, is an important factor behind the widening silver deficit. The Silver Institute projects a 17% increase in this deficit, fueled by a 2% rise in demand and a 1% decline in supply. Silver’s indispensable role in solar cell manufacturing, due to its superior electrical conductivity, thermal efficiency, and optical reflectivity, has contributed significantly to its outperformance of both the S&P 500 and gold so far this year.

• Despite potential upward pressure on both gold and silver prices due to heightened global power competition, silver may have a slight edge. The gold-to-silver price ratio currently exceeds its historical average of 70, suggesting a possible correction in the coming months. Furthermore, silver’s industrial applications, particularly in green energy initiatives, provide a strong foundation for its price support. As a result, we do not expect silver to fall below the psychological barrier of $30 an ounce any time soon, especially as investors look to real assets due to rising geopolitical tensions.

Milei Losing His Hold: The Argentine president has seen his popularity fall as his economic policies have started to take hold.

• Support for Milei’s government declined by 15% in September, in the sharpest decline since he took office. His approval rating now stands at 44.8% of the population, with 50.7% expressing dissatisfaction. His declining popularity has been linked to his pro-market reforms, which have received applause from investors but also pushed the country into recession. The drop in support comes as he struggles to manage a small minority government while attempting to address the country’s ailing fiscal deficit and attract foreign investment.
• Despite the initial economic hardship, the government’s reforms are beginning to yield positive results. While inflation in Argentina remains one of the world’s highest, it has shown noticeable signs of easing over the last few months, with nearly all components of its inflation index moderating. Moreover, the country has achieved consecutive budget surpluses for the first time since 2010. These achievements have helped show that his policies, while not conventional, have the potential to put the country on the right track for growth, assuming that they can stay in place.

• Argentina’s long-term outlook will continue to improve as long as Milei can help the country regain legitimacy following its 2020 sovereign default. Despite Argentina’s history of market reforms, its sustainability remains uncertain. If Milei’s popularity continues to decline, he may be forced to delay or abandon further reforms. If conditions deteriorate enough, it is possible that he may be pushed out of office in the next election, mirroring the fate of previous pro-market Argentine presidents. Therefore, it’s crucial to consider the broader political landscape when evaluating the potential impact of a new leader on the market.

In Other News: Former President Donald Trump and Vice President Kamala Harris have committed to participating in town halls for Univision, which are aimed at providing voters with a deeper understanding of the presidential candidates. Meanwhile, optimism is rising that Congress will reach an agreement on a stopgap spending bill to avert a government shutdown ahead of the election. Additionally, the Department of Justice has announced plans to file a lawsuit against Visa, alleging that it holds a monopoly over debit card transactions.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with news of a new economic stimulus program in China, although economists are already panning it as insufficient to significantly boost growth. We next review several other international and US developments with the potential to affect the financial markets today, including signs of stable interest rates in Japan and Australia and an update on the threat of a major strike at the US’s East Coast and Gulf Coast ports in just one week.

Chinese Economy: In a new effort to boost flagging economic growth, the Chinese government today unveiled a large package of stimulus measures. For example, the People’s Bank of China cut its benchmark interest rate and reduced bank reserve requirements to free up cash for lending. The central bank will also provide the equivalent of about $70 billion to funds, brokers, and insurers to buy Chinese stocks, along with about $40 billion to banks to finance stock buybacks by listed firms. For consumers, interest rates on existing mortgagees will be reduced.

• While today’s stimulus package is bigger than recent ones, economists so far are dubious that it will be enough to offset the strong structural impediments to growth in China, such as weak consumer demand, poor demographics, and excess capacity and debt. The central government’s crackdown on excessive housing investment and the poor state of provincial and local government finances are especially problematic.
• If the new measures fail to spur much growth, China’s economic slowdown will continue to weigh on the global economy and geopolitics. For example, weak Chinese demand would weigh on imports and put additional downward pressure on many commodity prices. It would also incentivize Beijing to spur more factory investment and boost exports, leading to protectionist measures abroad and new trade tensions.
• All the same, the broad stimulus package and the stock-specific measures in particular have given a strong boost to Chinese stocks so far today.

Chinese Military: Illustrating China’s rapid military buildup, Beijing this week had three aircraft carriers underway simultaneously for the first time in history. The fully commissioned Liaoning and her battle group are operating east of the Philippines, while the Shandong and her battle group are in the South China Sea. Meanwhile, China’s newest and most technologically advanced carrier, the Fujian, is on her fourth sea trial in the Yellow Sea. The only US carrier in the region, the Theodore Roosevelt, is operating east of the Philippines.

Israel-Hezbollah: Over the last day, Israel has unleashed a massive campaign of air attacks against Hezbollah targets in Lebanon, destroying large numbers of Hezbollah missile launchers, weapons caches, and other military equipment. However, the campaign has also resulted in the deaths of almost 500 people. The escalating violence continues to present the risk of a wider, highly destabilizing regional war that could draw in the US.

Japan: Despite investor expectations for another interest-rate hike next month, Bank of Japan Governor Ueda said in a speech today that the policymakers can wait to gather more data on economic developments. Importantly, he stressed that the yen’s (JPY) recent appreciation could help hold down import prices and overall inflation. The statement suggests the BOJ may hold rates steady at its October policy meeting, just as it did at its meeting last week. In response, the yen has weakened by about 0.3% so far today to trade at 144.01 per dollar ($0.0069).

Australia: The Reserve Bank of Australia today held its benchmark short-term interest rate unchanged at 4.35%, as expected. The decision reflects how Australian policymakers remain wary about the country’s tight labor market and still-elevated price inflation. It also makes Australia an outlier among major central banks other than the BOJ, most of which have now begun to cut rates. As a result, the Australian dollar (AUD) today has strengthened 0.2% to $0.6855.

France: The new French government, which is under an “excessive deficit” procedure by the European Union, has reportedly asked Brussels for two extra weeks to deliver its plan for reducing its budget shortfall and bringing its debt under control. If approved, the new deadline would be October 31. The French deficit procedure is being seen as a test of how strongly Brussels will act to enforce fiscal discipline among EU member countries.

• Reflecting investor concern about France’s debt levels, the country’s 10-year government bond yield of 2.98% is now as high as Spain’s for the first time since 2008.
• French government bond yields are also now trading at a spread of 0.79% over the benchmark German yield.

United States-Turkey: Washington and Ankara are reportedly close to a deal in which Turkey will end its acquisition of Russian-made S-400 air defense systems in return for the US allowing it back into the F-35 fighter program, both as a purchaser and a components producer. The deal would also transfer the S-400 systems already acquired to the US sector of the Incirlik Air Base, where the US military could presumably test them and figure out how to defeat them.

• Until now, Turkish President Erdoğan had exemplified the “border lands” leader who tried to play the US and its bloc off against the China/Russia bloc.
• It now appears the US was able to bring Turkey to heel by cutting it off from acquiring or helping to manufacture the F-35, which is widely recognized as the world’s most advanced jet fighter. If so, the incident highlights how the US is likely to leverage access to its advanced technologies to keep allies in line or punish its adversaries.

US Politics: At a campaign rally in Pennsylvania yesterday, former President Trump warned farm equipment maker Deere & Co. that, if elected in November, he would impose 200% tariffs on any of the firm’s made-in-Mexico equipment that had previously been made in the US. While it is unclear whether US law would allow for such a tariff hike on a single company, the threat illustrates how protectionism in the interest of preserving US jobs has become accepted policy for both Republicans and Democrats.

US Shipping Industry: The US is now just one week away from a potential major strike at dozens of East Coast and Gulf Coast ports. If the US Maritime Alliance, which represents carriers and marine terminal operators, and the International Longshoremen’s Association do not agree on a new contract before the current one expires on September 30, the resulting work stoppage would affect about 41% of the country’s containerized shipping volume.

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