by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is refocusing its attention on the Fed’s rate decision later today. In sports news, the Golden State Warriors defeated the Boston Celtics. Today’s Comment will discuss why investors should not be overly focused on policy agenda. We will also take a deep dive into why small cap stocks have been outperforming the overall market and explore the possibility of snap elections in Germany. As usual, the report will conclude with a roundup of international and domestic data releases.

Red Wave: The S&P 500 had its best post-election rise in history as investors prepare for a Republican takeover of the executive and legislative branches of government.

• Republicans are projected to secure 53 Senate seats and possibly exceed the 218-seat threshold needed to control the House. This anticipated shift has caught investors’ attention, as control over both chambers of Congress means that lawmakers will face fewer obstacles in pushing through pro-growth measures such as tax cuts and the removal of regulations. Financials and Energy outperformed, as both sectors are expected to be big winners. Additionally, there is increasing optimism that AI will face less oversight, potentially boosting research and development in the tech space.
• While policy agendas can be influential, they don’t always drive market returns. As JP Morgan Global Market Strategist Meera Pandit highlights, during Trump’s first term, the S&P Global Clean Energy Index outperformed the S&P Energy Index, rising 275% compared to -40%, respectively. Conversely, under Biden, the overall energy index outperformed clean energy, returning 211% versus -54%, respectively. This happened despite Trump’s pro-fossil-fuel stance and Biden’s focus on clean energy. This contrast underscores the importance of looking beyond policy rhetoric to understand broader market forces.

• A key risk during this period of policy optimism is that unfavorable market conditions could undermine the effectiveness of certain policies. While tax cuts will help boost earnings and consumption, the effects of policy changes are less clear. In short, although Republican influence on policy decisions is noteworthy, external factors such as trade relations, economic trends, and geopolitical tensions are likely to have a greater impact on sector returns. Therefore, investors should exercise some caution before participating in the current rally.

The Small Cap Rise: The Russell 2000 surged ahead of its larger peers as markets anticipate pro-growth policies from Trump’s win.

• The day after Trump’s victory, the Russell 2000 index surged nearly 6%, marking its largest post-election gain since the index began in 1978. This strong performance was no anomaly; the second-largest gain followed Trump’s surprise win in 2016. The rally was fueled by expectations that Trump would push through tax cuts and remove restrictions that would help drive growth and boost corporate profits. Consequently, investors showed a heightened risk appetite, focusing on small cap Communication Services and Financials as the sectors are relatively cheap compared to its peers.
• A key difference between Trump’s initial term and now is the changing macroeconomic landscape. While recent indicators show improvement, small cap companies still face strong headwinds, including high labor and borrowing costs and persistent inflation — all of which have pressured earnings growth. Continued market confidence in small cap stocks will largely depend on the Fed’s ability to engineer a soft landing and achieve economic growth alongside declining inflation. This would likely boost revenues and reduce borrowing costs, thereby improving profitability.

• While some initial optimism may wane in the coming weeks as investors seek further clarity from the administration, the long-term outlook for small cap stocks appears to be improving. Assuming the administration avoids more extreme policy actions, such as challenging the Fed’s independence, the market is likely to view the election as a positive catalyst. This positive sentiment is expected to persist throughout much of 2025, as the Republican-led government is likely to hit the ground running by removing burdensome regulations and implementing tax cuts.

Germany on the Cusp: The German government teeters on the edge of collapse as the ruling coalition’s deep divisions are proving to be insurmountable.

• On Wednesday, German Chancellor Olaf Scholz dismissed Finance Minister Christian Lindner over disagreements on spending and economic reforms. This decision effectively removes the fiscally conservative Free Democrat Party from the coalition and paves the way for a no-confidence vote scheduled for mid-January. If Scholz loses, which is highly probable, then there would likely be snap elections in March. Polls show that the right-wing Christian Democrats (CDU) and the anti-immigration Alternative for Germany (AfD) are the two most popular parties, with the Social Democratic Party (SPD) in third.
• The collapse of the coalition government coincides with a period of significant economic weakness. Industrial production has stagnated since 2017, and annual GDP growth is on track to fall for the second consecutive year. Factory activity has notably plummeted, with key sectors like automotive, chemical, and engineering experiencing sharp declines. These issues have been exacerbated by high energy costs, elevated labor expenses, and insufficient infrastructure investment. While consumer sentiment has improved due to easing inflationary pressures, it remains relatively low.

• New elections could boost right-wing parties, but their ability to form a government remains uncertain. The center-right CDU’s refusal to ally with the far-right AfD means it would need significant support and partnerships with smaller parties to secure a majority. Alternatively, a coalition could emerge between the Social Democratic Party and the rising left-wing alliance led by Sahra Wagenknecht. The composition of Germany’s next government will impact equities, with a CDU-led government generally viewed as the most market-friendly outcome.

In Other News: Mitch McConnell has expressed his belief that the filibuster will remain in place if the GOP takes control of both the House and the Senate. The Bank of England has cut its policy rate by 25 basis points but did not indicate any further rate changes for this year. In October, Chinese exports grew by 12.7% year-over-year, marking the fastest pace of growth since 2022.

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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 the election results. In sports news, Sporting Lisbon achieved a stunning upset by defeating Manchester, the defending champions, with a score of 4-1. Today’s Comment will discuss the election results, provide a preview of the upcoming FOMC meeting, and offer an update on the Iran-Israel conflict. As usual, the report will conclude with a roundup of both international and domestic data releases.

Election 2024: The Republican party appears to be on pace to sweep all three houses of government.

• Donald Trump secured another presidential term after successfully sweeping all of the swing states. He currently holds over 277 electoral votes and is expected to finish with around 312. His victory also lifted several down-ballot Republicans, including Bernie Moreno in Ohio, who unseated Democratic incumbent Sherrod Brown. The House remains closely contested, with Republicans gaining one seat and slightly increasing their majority, while swing seats are still in play for Democrats. Following Trump’s win, equities rallied, the dollar strengthened, and 10-year Treasury yields surged as investors doubled down on the so-called “Trump trade.”
• Trump’s return to power has sparked speculation about a possible growth shock. On the campaign trail, he proposed a series of stimulus measures that included lowering the capital gains tax, removing of the cap on SALT deductions, eliminating taxes on tips, and exempting firefighters, police officers, active-duty military, and veterans from paying taxes. Additionally, the decision to deregulate is also likely to help boost corporate profits. While campaign promises are likely to face some sort of adjustment to make them more palatable, it seems that the market is taking Trump at his word.

• Post-election optimism is expected to buoy equity markets in the coming weeks as investors speculate about the potential impact of the next presidency. A Republican president with a divided Congress often provides a balance that can temper more extreme policy shifts, potentially supporting equities and mitigating a rise in yields. Conversely, a Republican sweep could boost equities but also lead to increased bond yields. While Republicans currently hold a slight advantage, the final majority could be razor-thin, potentially as close as a single seat.

The Fed’s Next Move: The FOMC is set to start its two-day meeting on Wednesday as it looks to bring down policy rates and continue its easing cycle.

• Market sentiment strongly favors a 25 basis point interest rate cut by the Federal Reserve on Thursday, with the CME FedWatch Tool indicating a 97.5% probability. This expectation is fueled by recent economic data, which shows a cooling inflation and labor market. The Personal Consumption Expenditure (PCE) price index, the Fed’s preferred inflation gauge, declined to 2.1% in September, while core PCE remained steady at 2.7%. Additionally, the Bureau of Labor Statistics’ payroll report revealed a significant slowdown in job growth, with only 12,000 jobs added in October, which is well below the consensus estimate of 100,000.
• That said, investors will also seek clarification on the Fed’s future policy direction. While the previous dot plot indicated a median projection of a 50-basis-point cut for the federal funds rate, it was driven a single vote majority. This suggests that the November cut may be the last for the year. The Fed’s decision will likely hinge on whether it observes sufficient progress in reducing inflation over the next two months. For core PCE to decline below 2.7% in this timeframe, prices would need to remain essentially unchanged from October levels, which seems unlikely given current trends.

• The key focus of this week’s FOMC meeting will be the committee’s interpretation of recent economic data. If it dismisses the weak employment figures as an anomaly, it may become more cautious about further rate cuts. However, if it maintains its assessment of a cooling labor market, it could signal a more accommodative stance. Given the inconsistent nature of recent data, it’s difficult to draw definitive conclusions about the trajectory of inflation and the labor market. As such, we anticipate that the Fed will likely provide limited guidance, leading to relatively muted market reactions.

Israel Uncertainty: Prime Minister Benjamin Netanyahu has fired a member of his cabinet who was one of the strong proponents for a ceasefire in a sign that the conflict is not getting any closer to ending.

• Israeli Defense Minister Yoav Gallant was dismissed by Prime Minister Netanyahu amid ongoing disagreements over conflict strategy, with Netanyahu citing trust issues as the primary reason. Gallant, a strong advocate for a Gaza ceasefire to secure the release of hostages, is now absent from the cabinet, removing a prominent voice for negotiation. His removal has sparked nationwide protests, reflecting distrust with the handling of the war. This decision comes as Israel fights on two fronts against Iranian proxies Hezbollah in Lebanon and Hamas in Gaza, while bracing for possible retaliatory action from Iran.
• Israel’s deepening internal divisions are making it increasingly difficult for the US to prevent a wider regional conflict. On Tuesday, the US issued a stark warning to Iraq, demanding that it prevent Iran from launching attacks on Israel from its territory. According to US intelligence, the Islamic Revolutionary Guard Corps recently transferred ballistic missiles to Shia militias in Iraq, signaling preparations for imminent attacks. These heightened tensions have already caused oil prices to surge nearly 6% since Iran threatened retaliation for Israeli airstrikes.

• Gallant’s dismissal signals that a ceasefire may not be imminent, though the potential for further escalation remains uncertain. While Iran has expressed intent to retaliate for recent strikes, it remains vulnerable to counterattacks on its energy and nuclear facilities after Israeli forces recently weakened its air defenses. Meanwhile, ongoing protests within Israel reflect growing public discontent, suggesting limited tolerance for prolonged conflict. In the coming weeks, Netanyahu may face increasing pressure to pursue a ceasefire, which could clarify the conflict’s trajectory.

In Other News: EU regulators have fined Apple under the Digital Markets Act, signaling that the European Union is preparing to adopt a stricter approach toward US tech companies. Meanwhile, German Chancellor Olaf Scholz is expected to convene a meeting with his three coalition partners as he seeks to avert a potential breakup. Brazil’s central bank is expected to raise its benchmark rate by 50 basis points later today to combat rising inflation.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment on this Election Day opens with a few words on opinion polls. After all, those are all we’ll have to look at until actual voting results start to come in later this evening. We next review several other international and US developments with the potential to affect the financial markets today, including a potential reprieve for Germany’s fragile coalition government and an end to the machinists’ strike at Boeing.

US Politics: As the US holds its elections today, the latest FiveThirtyEight average of national polls shows Harris with 48.0% support and Trump with 46.8%, well within all the surveys’ margins of error. In the swing states, the support for each candidate is also evenly matched and within the margins of error. Since we’re all likely to hear a lot about polls today, we thought it might be useful to provide a quick reminder of how these polls work and what the margin of error really means:

• For whatever measure we’re interested in — say, the share of voters who support former President Trump — there is a certain, specific number within the population as a whole. Let’s say it’s 49.2%. The problem is that to find this actual number, you’d have to ask each and every person in the population. That would be expensive and probably impractical.
• As an alternative, polling firms select a random sample of individuals in the population and use that to develop an estimate of the actual population number. Under the laws of mathematics, and assuming the sample is designed correctly, it’s possible to estimate the number of individuals you need in the random sample to generate a reasonably accurate estimate of the actual number in the population. Polling is expensive, so pollsters don’t want to over-do it. This is why you often see samples sizes of just 1,000 to 3,000.
• Let’s say you conduct your survey, and 50.5% of the individuals in your random sample say they support Trump. This is higher than the actual population number of 49.2%, but you don’t know that. However, based on the size of the random sample and the characteristics of the population, it’s possible to calculate how certain you should be that the actual population number is within a certain distance of your calculated sample estimate. This is the margin of error.
• The margin of error basically says that if you used the same sampling methodology 100 times, you would expect some share of the 100 sample estimates to fall within a number x and a number y, at a specific level of certainty. A commonly used level of certainty is 95%. Based on mathematical laws, for example, you may estimate that in your hypothetical 100 samples, 95% of your calculated support numbers for Trump would fall between 49.0% and 52.0%.
• Indeed, rather than focusing on the specific point estimates of the various polls, it may be good to focus more on the range implied by the margin of error. Think of the polls as saying, “We think there is a 95% chance that the true population support level for Candidate Z is between x% and y%.” Maybe that’s another way of saying we should all be careful about relying too much on the polls!

Germany: Just days after Finance Minister Lindner of the liberal Free Democratic Party proposed spending reforms that threatened to end the coalition government, as we reported in our Comment yesterday, Deputy Chancellor Habeck of the Greens offered a budget compromise aimed at keeping the coalition together. However, it isn’t clear if Habeck’s proposal will keep the three-party coalition together. As a result, Germany is likely to face continued political and economic uncertainty in the coming months.

Russia-United States: In an in-depth article yesterday, the Wall Street Journal described an apparent effort by Russia’s intelligence services to start fires on passenger or cargo aircraft flying to the US. In an apparent test run of the plan, magnesium-based devices in packages shipped via DHL ignited at sorting facilities in the UK and Germany. We first saw reporting on the incidents several months ago, but only now has the story been picked up by the major media.

• US and European national security officials warn that the sabotage program marks an unusually aggressive and risky new approach for the Russian intelligence services. They warn that the services could even be acting outside of the control of the Kremlin.
• The risk for investors is that a successful attack could cause a catastrophic airliner crash that kills US citizens. Even though former President Trump is often seen as supportive of authoritarian leaders such as Russian President Putin, we also note that his foreign policy type is “Jacksonian.” If he is re-elected today, his instinct for isolationism could abruptly shift toward punching back hard if US honor is besmirched or if US citizens are killed by a foreign power, even if that power is Russia.

Australia: The Reserve Bank of Australia today held its benchmark short-term interest rate steady at 4.35%, meeting expectations and marking a full year at that level. In its policy statement, the RBA noted that while Australian economic growth has slowed markedly, core price inflation remains stubbornly high. The result is that the RBA is now a clear outlier among major central banks, most of which have been cutting rates.

China: The Caixin purchasing managers’ index for services rose to a seasonally adjusted 52.0 in October, up from 50.3 in September. Like most major PMIs, the private-sector Caixin gauge is designed so that readings over 50 indicate expanding activity. The Caixin services index has now been above that level for 22 straight months, illustrating how the current headwinds in China’s economic growth is in the manufacturing sector, which is saddled with excess capacity.

United States-China: Under pressure from Washington, top US semiconductor equipment makers Applied Materials and Lam Research have told their suppliers to stop using certain components from China or they will risk losing their status as vendors. The firms have also told their suppliers that they can’t have Chinese investors or shareholders.

• The warnings are the latest example of how the US and China are putting up barriers to the flow of technology between the two countries.
• As we have argued many times before, those barriers may enhance national security and resilience, but they could also raise costs and contribute to higher price inflation and interest rates going forward.

US Monetary Policy: As a reminder, the Fed holds its latest monetary policy meeting this week, with its decision due on Thursday at 2:00 PM ET. The policymakers are widely expected to cut the benchmark fed funds interest rate by 25 basis points to a range of 4.50% to 4.75%, and we agree with that assessment. However, because of the underlying strength in economic growth, relatively tight labor markets, and continued price pressures, we still think the pace and endpoint of future cuts could leave investors disappointed.

US Labor Market: Boeing’s 33,000 union machinists have finally ratified a new labor contract that will give them a 38% pay hike spread over four years and end their nearly two-month strike against the company. However, we note that the pay hike is more muted than workers gained in some other recent high-profile strikes. In part, that likely reflects Boeing’s idiosyncratic operational and financial challenges. However, it could also partly reflect the nation’s somewhat slower economic growth and cooler labor market.

US Residential Real Estate Market: According to data firm CoStar, the third-quarter apartment vacancy rate held steady at 7.9%, marking the first time in three years that the share of empty units didn’t increase. The figures suggest the recent slowdown in apartment construction and still rising demand will help reduce excess supply and lead to improved rental rates in the coming year.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with a few words on tomorrow’s election, which we still consider a coin-flip. We next review several other international and US developments with the potential to affect the financial markets today, including an OPEC+ decision not to start boosting oil production as early as planned and an outlook for the Federal Reserve’s latest monetary policy decision on Thursday.

US Elections: Election week is now upon us, and voters tomorrow will cast their ballots for president, senators, representatives, governors, state lawmakers, judges, county commissioners, referenda, initiatives, bond proposals, and probably even a local dog catcher or two. At least 65,000,000 voters have already cast advance ballots. In our view, the race for president and Congress remains too close to call and could go either way, from a landslide for the Republicans to a landslide for the Democrats.

• Our read of the situation is based on a broad, triangulated reading of the opinion polls, betting markets, analysis by reputable political observers, and insider commentary. No matter who you support in the election, we would caution against over confidence, since that could merely set you up for disappointment and anger.
• Supporting our view that the election could go either way, we note that a range of indicators point in different directions. For example, recent polls point to a rebound in support for former President Trump and betting markets suggest the odds are highly in his favor, but other data consistently shows that Vice President Harris enjoys higher enthusiasm among her supporters and out-sized support among women.
• In fact, a new poll suggests Harris could even win Iowa. The poll underscores a potential swing toward her, which has boosted bond prices, pushed down yields, and weighed on the dollar so far this morning. The benchmark 10-year Treasury yield has fallen this morning to 4.288%, and the US Dollar Index is down a sharp 0.6%.
• In any case, stock market performance has historically averaged about the same whether it was a Republican or a Democrat in the White House. The more important issue may be whether we end up with a unified or split government. Historically, the market has performed best in a split government, when one party has the White House and the other has at least one chamber of Congress. Given today’s close division of support, we believe there is a good chance that we’ll end up with a market-friendly split government.
• Finally, we note that emotions are high, and politicians and foreign agents alike appear to be prepping the ground for protests or even violence once the results are announced. We can’t discount the possibility of political and legal uncertainty, protests, or even localized violence between Election Day and Inauguration Day. As of right now, however, we think any such developments would be relatively short-lived and contained.

Global Oil Market: In a notice posted Sunday by the Organization of the Petroleum Exporting Countries, Saudi Arabia and seven other oil-producing nations said they wouldn’t implement their plan to gradually hike oil production until at least late December. The move likely reflects the current over-supply of oil amid strong US output, weak economic growth in China, and reduced demand for automotive gasoline as consumers buy more electric vehicles.

Global Wine Market: New data from the International Organization of Wine and Vine shows global wine consumption in 2023 fell to 221 million hectoliters, down a full 10.5% from 2017. The drop is the equivalent to about 3.5 billion bottles of wine per year, largely because reduced consumption by baby boomers isn’t being offset by younger drinkers. The decline has led to excess supplies of both wine and grapes, which is starting to weigh on prices.

Germany: The fragile three-party coalition government was thrown into further disarray on Friday evening when someone leaked an economic position paper by Finance Minister Lindner, who heads the coalition’s liberal Free Democratic Party. The paper argued for new tax and spending cuts, which are at odds with the policy proposals of the other coalition partners, the center-left Social Democratic Party, and the left-wing Greens. The disagreement could shatter the coalition and bring it down shortly after the US election, leading to a weak caretaker government.

United Kingdom: The Conservative Party on Saturday elected former Minister of Business and Trade Kemi Badenoch as its new leader. Badenoch, whose parents are Nigerian immigrants, has vowed to shift the party more aggressively to the right, with a focus on social issues such as further curbing immigration and combating “woke” culture. However, the more popular Labour Party is likely to remain in power until the next scheduled elections in summer 2029.

Moldova: In a run-off election yesterday, President Maia Sandu won a second term with 55.4% of the vote, beating the Russia-backed opposition candidate Alexandr Stoianoglo. The win by Sandu will help keep the small, Eastern European country oriented toward the West and focused on its effort to eventually join the European Union.

Australia: Fitch Ratings today reaffirmed Australia’s stellar sovereign debt rating of AAA, with a stable outlook. The firm praised Australia’s “high income per capita and sound medium-term growth outlook, as well as [its] strong institutions and an effective policy framework.” Still, it also noted the budget deficit would likely widen to 2.6% of gross domestic product in fiscal year 2025, up from just 0.8% in FY 2023, largely because of tax cuts and fast spending hikes.

China: The Ministry of Commerce and the China Securities Regulatory Commission have announced easier rules on Qualified Foreign Institutional Investors (QFIIs) seeking to buy Chinese “A” shares, which trade only on the mainland and can’t be directly purchased by foreign individuals. To qualify as a QFII, for example, the new rules require the institution to have capital of at least $50 million or assets under management of at least $300 million, down from the previous requirements of $100 million and $500 million, respectively.

• The move is consistent with the economic stimulus measures Beijing announced earlier in the autumn, which partly aimed to boost Chinese stock prices and give Chinese citizens a viable alternative way to build wealth as the country’s residential housing market continues to struggle.
• The eased rules are also consistent with Beijing’s newly adopted goal to make China a “financial superpower.” However, even with the new changes, Beijing will still have tight control over cross-border inflows and outflows of capital. Those controls will likely keep acting as a disincentive to foreign investors and inhibit the renminbi from becoming a more viable reserve currency.

China-Peru-United States: The head of US Southern Command, Army Gen. Laura Richardson, has warned that a new China-funded megaport in Peru could be used by the Chinese navy. The new port, due to be inaugurated by General Secretary Xi this month, is the latest example of Beijing’s strategy to build ostensibly civilian maritime facilities around the world, which it could then use for naval operations in a conflict. Since the Peru port could allow the Chinese navy to threaten the western approaches to the US, it could further worsen US-China tensions.

• On a related note, the head of US Space Force, Gen. B. Chance Saltzman, warned late last week that China is developing and launching space weapons at a “mind-boggling” pace. According to Gen. Saltzman, China and Russia are both demonstrating an ability to conduct warfighting in space, which he called “very threatening” to the US and its allies.
• To reiterate, the continued aggressive military buildup by China and Russia are likely to further exacerbate US-China tensions, creating continuing risks for investors.

US Monetary Policy: The Fed holds its latest monetary policy meeting this week, with its decision due to be released on Thursday at 2:00 PM ET. The policymakers are widely expected to cut the benchmark fed funds interest rate by 25 basis points to a range of 4.50% to 4.75%, and we agree with that assessment. However, because of the underlying strength in economic growth, relatively tight labor markets, and continued price pressures, we still think the pace and endpoint of future cuts could leave investors disappointed.

US Stock Market: Reflecting how fortunes have shifted for two of the country’s key technology giants, Dow Jones late last week announced that Nvidia, the graphics processor maker turned artificial-intelligence darling, will replace Intel, the past king of central processing chips that is now struggling to compete, in the Dow Jones Industrial Average. The change will be effective prior to market opening on Friday, November 8.

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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 the latest jobs data. In sports news, Carlos Alcaraz was eliminated from the Paris Masters’ quarterfinals in a surprising upset. Today’s Comment will discuss why the latest inflation figures further strengthen the Federal Reserve’s case for achieving a soft landing. We will also share our thoughts on how OPEC may respond to the US’s growing influence in the oil markets and conclude with a report on why the yen has begun to appreciate against the dollar. As always, our report includes both international and domestic data releases.

Inflation Cooling: The Fed’s preferred inflation and wage indexes both showed signs of cooling, suggesting that the central bank may be on track for a soft landing.

• The Personal Consumption Expenditure (PCE) Price Index, a key inflation gauge, increased 2.1% year-over-year in September. This represents a slight deceleration from the previous month’s 2.3% increase and aligns with market expectations. Core PCE, excluding volatile food and energy prices, remained stable at 2.7%. Meanwhile, the Employment Cost index, which tracks wage pressures, increased at an annualized rate of 0.8%, down from 0.9% in the previous quarter. The combined easing of inflation and wage growth provides further evidence that the Fed is closer to achieving its mandate.
• The Federal Reserve’s potential for multiple rate cuts remains on the table as wage and price pressures ease. Market expectations, as reflected in the CME FedWatch Tool, currently point to a near-certainty of a rate cut next week with a 70% probability of another in December. This confidence stems from the fact that inflation has shown a consistent downward trend throughout the year, with price pressures rising at a slower pace compared to the previous year. As the chart illustrates, seven out of nine months in 2024 saw a deceleration in core PCE price growth compared to the previous year.

• The Fed’s ability to navigate a soft landing hinges on its avoiding complacency. By carefully easing monetary policy and monitoring the normalizing labor market, the central bank can mitigate the risk of a reversal or hard landing. The next three months will be a critical test, as lower inflation readings are typically observed during this period. A substantial acceleration in October or November could lead the Fed to hold off on cutting rates in December. That said, a cut at next week’s meeting does seem reasonable.

Market Share or Margins: OPEC is facing challenges in developing a strategy to address the growing competition from US oil production.

• US oil production reached a record 13.4 million barrels per day in August, helping to keep prices from surging despite escalating tensions in the Middle East. The increase was driven by Texas and New Mexico, which produced 5.8 million and 2.1 million barrels per day, respectively. Recently, strong US production has boosted its share of global oil production to nearly 22% in 2023, up from 19% in 2020. In contrast, top oil producer Saudi Arabia has maintained a steady output share of around 11%.
• The US’s emergence as a major oil producer has curtailed OPEC’s ability to influence global oil prices through production cuts. Despite efforts to curb supply, the oil market remains saturated due to weakening global demand, particularly from China. As a result, Saudi Arabia, OPEC’s most influential member, has experienced declining revenue from both lower oil prices and reduced production. This has compelled OPEC to explore strategies to bolster profitability, as many of its member nations rely heavily on oil revenues to fund their governments.

• OPEC is poised to address the global oil oversupply issue at its December meeting. While production cuts to bolster prices remain a possibility, the cartel may alternatively opt to flood the market to weaken competitors and regain market share. OPEC’s decision will likely depend on its assessment of global economic growth in the coming months. A positive outlook on global growth could prompt production cuts, supporting oil prices. Conversely, a pessimistic forecast for the global economy may lead to increased production, putting downward pressure on prices.

Japanese Yen Resurgence: Speculation over monetary policy has led the yen (JPY) to strengthen and Japanese equities to fall.

• On Thursday, Bank of Japan Governor Kazuo Ueda announced that the central bank would no longer state that it can “afford time” on future rate hikes, acknowledging that fluctuations in foreign exchange rates are having an effect on domestic price pressures. His comments marked a hawkish shift from the previous day’s more general BOJ statement, which had suggested that any rate increases would depend on economic and inflation trends aligning with the bank’s forecasts. Following Ueda’s remarks on Thursday, the Japanese yen surged 1% against the dollar at its highest.
• Since September, the country’s currency has depreciated significantly against the dollar, falling nearly 7%. This sharp devaluation was likely driven by a sudden shift in global interest rate expectations, primarily due to changes in market sentiment regarding central bank policies in the US and Japan. Following the September FOMC meeting, investors have begun to price in fewer rate cuts over the next few years. Additionally, the July market turmoil caused by the unwinding of the yen carry trade has led investors to believe that the Bank of Japan will adopt a cautious approach to rate cuts.

• Ueda’s comment suggests a potential hawkish shift in the BOJ, which should help support the JPY. We suspect that as long as uncertainty persists regarding the extent of the Federal Reserve’s planned rate cuts during its easing cycle, the BOJ will be forced to be more assertive with policy. Consequently, Japanese policymakers may seek to protect the yen by adopting a monetary policy stance that diverges from the Fed’s, potentially including a more hawkish rate hike at the December BOJ meeting.

In Other News: Canadian ports are bracing for strikes starting Monday, which are expected to cause supply chain disruptions across the country. Additionally, Iran has threatened to retaliate against Israeli attacks through proxy groups, resulting in a rise in oil prices. Furthermore, China sanctioned the largest US drone maker to signal its potential response to further trade restrictions imposed by the US.

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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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