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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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with news of a new Western alliance to help develop strategic mineral resources outside of China’s control. We next review several other international and US developments with the potential to affect the financial markets today, including a surprise win for the German ruling party in state elections yesterday and potential new US restrictions against automatic driving and vehicle communications technology from China and Russia.

Global Strategic Minerals Market: On the sidelines of the United Nations’ General Assembly in New York this week, the European Commission and 14 allied countries ranging from the US to Australia will announce a new Minerals Security Partnership (MSP) to finance strategic mineral projects around the world. To reduce China’s near monopoly on the supply of many key minerals, MSP participants will direct their development finance and export credit agencies to work with private industry in support of projects such as a new nickel mine in Tanzania.

• Now that the US and rest of its bloc have come to perceive the military and economic threat from China over the last decade or so, they have increasingly imposed trade, capital, and technology restrictions against Beijing. As we have noted in the past, the China bloc and the China-Leaning bloc will likely respond by weaponizing their chokehold on key minerals in the coming years.
• The US and allied governments recognize that threat and are working to reduce it. A key question for investors is whether those allied efforts will help shield Western companies from potential supply disruptions and/or create new opportunities in the basic materials or industrial sector.

United States-Japan-Australia-India: At the “Quad” alliance summit over the weekend, the US, Japan, Australia, and India approved a plan for joint coast guard patrols in the Indo-Pacific region starting in early 2025. Under the plan, coast guard vessels from the Quad countries would be jointly manned by US, Japanese, Australian, and Indian personnel as they patrolled against illegal fishing in the region.

• Although the patrols would be ostensibly against illegal fishing, the focus almost certainly would be on Chinese vessels, which have been particularly aggressive and numerous in the Indo-Pacific fishing grounds.
• The joint crews are clearly meant to send a message to Beijing that if it continues its aggressive efforts to assert sovereignty over the region, it will have to deal with all four Quad members, rather than just one.
• The move, therefore, is likely to raise tensions with Beijing and lead to further decoupling between the US and Chinese blocs, with big risks for global investors.

United States-China-Russia: As early as today, the US Commerce Department is expected to unveil new rules banning the use and testing of Chinese and Russian technology for automated driving or vehicle communications. The new restrictions aim to keep the Chinese and Russians from being able to track, spy on, or sabotage US drivers remotely — a concern heightened by Israel’s attack last week on Hezbollah militants using compromised pagers and walkie-talkies.

• The US and allied governments have long worried about China-bloc countries infiltrating internet-connected equipment, from port cranes to electrical-grid computers, to spy on the West or be able to disable those systems in time of conflict. After the Israeli attack, it is now better understood that connected products, from cars and phones to refrigerators, can also be used for highly targeted kinetic attacks if their supply chains are compromised.
• In effect, Israel may have opened Pandora’s Box, which is now internet-connected. Having seen a successful kinetic attack using connected equipment whose supply chain was compromised, state and non-state actors around the world today are almost certainly exploring how they could do the same.
• In response, the US and other Western governments will impose even more restrictions on using connected goods or components from abroad. We suspect this will lead to further global fracturing as countries bring even more production back home or at least back to the friendly countries in their own geopolitical and economic bloc, despite the cost. As we have noted before, the result will be shortened, less efficient supply chains, higher and more volatile price inflation, and higher and more volatile interest rates.

Israel-Hezbollah: Following Israel’s attacks on Hezbollah last week, the militants dramatically increased their tempo of missile and drone strikes against Israel over the weekend. They also struck Israeli targets much farther to the south than they previously had and claimed the volley was only the beginning of a new phase. Israeli Prime Minister Netanyahu warned of even stronger attacks by Israel. In sum, there seems to be an increasing risk of a broader, more intense conflict in the region that could draw in the US and other regional powers and be highly destabilizing.

European Union-China: As the EU considers serious antidumping tariffs against the growing flood of Chinese electric vehicles, an EU industry group representing steelmakers has appealed for protection against a growing wave of metal imports from China. If the appeal results in a new antidumping investigation by the EU or eventual tariffs, it would signal further EU-China trade tensions and increased risk of a trade war that could hurt companies on each side.

Eurozone-Italy-German: Italian lender UniCredit said it has lifted its position in Germany’s Commerzbank to 21%, up from the 9% that unsettled the German government when it was announced two weeks ago. UniCredit has also applied to the European Central Bank to increase its holding in Commerzbank to 29.9%. The moves signal that UniCredit may be prepping a hostile takeover, which, if successful, could spur a new round of bank consolidation in the eurozone.

Germany: In Brandenburg’s state elections yesterday, the ruling center-left Social Democratic Party (SPD) is on track to eke out a win, with a projected 31% of the ballots, just ahead of the right-wing populist Alternative for Germany (AfD) with 30%. The far-left BSW party appears to have jumped to 13% of the vote. If the SPD’s win is ultimately confirmed, it would provide a reprieve for Chancellor Scholz and at least postpone new elections in the country.

Sri Lanka: In yesterday’s general election, Marxist candidate Anura Kumara Dissanayake won the presidency with about 42% of the vote, versus 33% for his closest rival. Dissanayake’s win marks a major turnaround from his dismal showing in the 2019 election, partly reflecting the electorate’s anger at traditional politicians who sparked an economic crisis in recent years. Going forward, however, the new president may have trouble pushing a fully leftist agenda, as he is required to name his cabinet from members of parliament, where his party has very few seats.

US Fiscal Policy: Republican and Democratic leaders in Congress yesterday agreed to a stopgap spending bill to fund the federal government from the end of the current fiscal year next Monday to December 20. If passed into law as planned later this week, the deal would avert the risk of a partial government shutdown right before the November election and give lawmakers more time to hash out spending plans for the remainder of Fiscal Year 2025.

US Nuclear Energy Industry: In a report Friday, Constellation Energy and Microsoft reached a deal in which Constellation will invest $1.6 billion to bring its Three Mile Island nuclear plant back on-line in return for Microsoft committing to a 20-year electricity purchase commitment to serve its artificial-intelligence efforts. The deal illustrates both the growing attractiveness of nuclear energy as a clean source of electricity and the rising electricity demands for AI.

• Those forces have already driven up electric utility stocks, and they could well continue doing so in the near term.
• After news of the deal, Constellation’s share price jumped 22.3% to close at $254.98.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Today’s market is still grappling with the implications of the recent rate decision. In sports news, Tina Charles etched her name in WNBA history, setting new records for career rebounds and double-doubles. Today’s Comment examines the market’s guarded optimism amidst the recent milestone of the S&P 500, the EU’s tightening regulations on US tech, and the implications of Japan’s monetary policy. As always, the report will include a comprehensive overview of domestic and international economic data releases.

S&P 500 Hits Highs: Equities continue to march forward as investors believe that a soft landing is possible.

• The S&P 500 reached an all-time high by surpassing 5700 on Thursday, marking its 39^th record of the year. The market’s buoyant sentiment was fueled by optimism that the Federal Reserve might have pivoted in time to avert a recession. Thursday’s decline in weekly jobless claims signaled continued reluctance among firms to lay off workers and showed a strong labor market. Meanwhile, the Atlanta GDPNow forecast model’s positive outlook also adds to the market’s optimism. Consequently, nearly every sector experienced gains, with technology stocks leading the way.
• However, beneath the surface, recessionary concerns linger. Despite recent mortgage rate decreases, existing home sales plummeted to a post-pandemic low in August. Moreover, FedEx, seen as an economic bellwether, missed profit targets and issued a warning of potential business slowdown in the coming quarters. The company attributed this to waning consumer demand for expedited shipping, further signaling rising price sensitivity within households. This sentiment was echoed in retail sales data released by the Commerce Department, indicating a growing number of online deal-seekers.

• The Fed’s recent shift in focus toward maximum employment over price stability will be tested next week by the PCE price index report. Recent data suggests that core inflation has made significant progress toward the Fed’s target, easing concerns about inflation risks. If core inflation rises modestly in August as expected, investors may become more confident in the Fed’s ability to achieve a soft landing. Fed speeches over the next week should also help guide market expectations as officials look to make their case that the central bank is not worried about recession.

The EU’s Digital Hurdle: The bloc has initiated a crackdown on foreign tech firms to bolster its regional presence in the industry.

• The EU has intensified its scrutiny of US tech giants under the Digital Markets Act. On Thursday, regulators cautioned Apple that it must allow competing tech firms access to its iPhone and iPad operating systems or face substantial fines. This warning reflects the EU’s broader effort to dismantle the dominance of foreign tech companies within the European technology market. Earlier this week, Google successfully appealed a $1.7 billion fine levied against its advertising business but agreed to divest this section of its company in order to resolve the ongoing antitrust probe.
• The EU’s escalating regulatory oversight of US companies signals a strategic pivot towards bolstering domestic industrial capabilities. As geopolitical tensions rise, the region is positioning itself for a more self-reliant future. A recent EU Commission study emphasized the imperative of developing a robust domestic technological infrastructure to mitigate risks associated with over-reliance on potential trade rivals, including China and the US. This shift is reflected in the region’s increased investment in military technology, which will rise from 142 million EUR ($158 million) to 1 billion EUR  ($1.1 billion) a year over the next few years.

• A more assertive EU is expected to maintain its alliance with the US, driven by strong ties and shared interests. However, amid rising geopolitical tensions, EU governments are likely to prioritize industrial policies that bolster domestic firms. This strategic shift could lead to increased investment and higher debt levels for EU countries, but the long-term benefits may include greater corporate competitiveness. Meanwhile, US firms may need to adapt their business models to focus more on domestic markets, as access to foreign markets could become more challenging.

Bank of Japan Holds: The BOJ opted to maintain a patient stance on monetary tightening, awaiting the potential inflationary effects of the yen’s (JPY) recent appreciation.

• On Friday, the central bank announced it would keep interest rates unchanged, signaling that further hikes are unlikely in the near term. During a press conference, BOJ Governor Kazuo Ueda stated that the bank would consider raising rates if inflation and economic conditions remain on their current path. He expressed optimism that the recent appreciation of the yen has provided more flexibility for policy decisions. Ueda also cited uncertainty around a potential US soft landing as a key factor in the rate decision.
• While inflation has been steadily rising, there are indications that underlying price pressures remain relatively contained. Although the central bank’s headline inflation rate reached 2.8% in August, a substantial increase from the year’s beginning, core inflation, excluding volatile food and energy components, remains below the target of 2%. This reinforces the central bank’s stance that it can delay interest rate hikes, given that the recent currency appreciation is expected to place downward pressure on import prices. Japan’s heavy reliance on imports for energy and food makes this particularly beneficial.

• The Federal Reserve’s perceived delayed response to labor market pressures may have influenced the BOJ’s decision to maintain a patient stance. Last month’s market selloff was triggered by the BOJ’s unexpected rate hike and the Sahm Rule activation. The event highlighted the financial markets’ vulnerability to abrupt currency fluctuations, particularly in the context of yen carry trade unwinding. The BOJ’s cautious approach may ultimately enhance financial stability, particularly if inflationary risks remain contained in both countries.

In Other News: The Biden administration admitted that it no longer believes it will be able to negotiate a peace agreement between Israel and Hamas, which may lead to the possibility of escalating tensions in the Middle East. A bipartisan group of lawmakers bypassed House Majority Leader Mike Johnson to force a vote on a bill to expand Social Security access, in a strong sign that his party is losing faith in him. Brazil fined X for defying a platform ban, demonstrating the escalating rift between the two sides.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Markets are still digesting the Federal Reserve’s latest interest rate decision. In sports news, Shohei Ohtani continues his historic season, aiming to become the first player to hit 50 home runs and steal 50 bases in a single year. Today’s Comment will delve into the Fed’s decision to cut rates, explore why the market is not sold on the economy, and provide an update on Germany. Our report will conclude with a roundup of international and domestic news.

Pivot Complete: The Fed launched its easing cycle with a jumbo rate cut but cautioned the market not to expect it to become a trend.

• The Federal Open Market Committee (FOMC) concluded its two-day meeting by reducing its fed funds target rate by 50 basis points to 4.75%-5.00%. While policymakers expressed optimism about inflation’s trajectory toward the 2% target, they also voiced concerns about the cooling labor market. In the subsequent press conference, Fed Chair Jerome Powell indicated that future rate cuts are likely to be smaller going forward, with a 25 bps rate cut expected over the next two meetings.
• Following the Fed’s policy pivots, doubts emerged about the central bank’s commitment to controlling inflation. The dot plot revealed lingering concerns among committee members, with nearly half opposing more than one additional cut for the rest of year. Meanwhile, Michelle Bowman was the first governor since 2005 to dissent, having favored a smaller cut. These factors likely contributed to the slight steepening of the yield curve, with the 10-year Treasury yield rising more quickly than the two-year Treasury yield.

• Investors are shifting their attention from solely focusing on the Federal Reserve’s interest rate policy to broader economic factors like growth, inflation, and the national debt. Furthermore, the timing of the Fed’s exit from quantitative tightening could significantly influence bond yields due to its effect on the bond market supply. Despite these factors, we expect limited downward pressure on bond yields in the near term. In fact, upward pressure may emerge if economic indicators suggest rising inflation or stronger job growth.

Why the Gloom? The market offered mixed signals about the path forward for equities following the Fed’s pivot.

• Despite the initial positive reaction to the Fed’s rate decision, the S&P 500 and Nasdaq Composite indexes both closed slightly lower than the previous day, while the S&P 600 small cap price index experienced only minor gains. While some of this weakness can be attributed to profit-taking by investors who had bet on a specific outcome of the two-day meeting, the overall sentiment suggests underlying skepticism about economic growth. While the central bank expressed optimism about the US economy, the big rate cut does suggest that it is ready to take more aggressive steps if needed.
• There is major concern that the labor market might be cooling more rapidly than the central bank realizes. Since the Sahm Rule was triggered in July, there has been mounting evidence suggesting that firms are reducing their hiring. Recent payroll data reveals a significant slowdown in private-sector job creation, with the average for the past three months falling below 100,000 jobs — nearly half the rate that was observed in 2023. Additionally, the number of jobs available has also slipped, with the job vacancy rate falling to its lowest level since 2020.

• Despite recent economic concerns, there are positive signs. Jobless claims remain relatively low, indicating that firms are reluctant to lay off workers. Additionally, the Atlanta Fed’s GDPNow forecast has been revised upward from a week ago, suggesting a strengthening economic outlook. This strong growth suggests that businesses are well-positioned to maintain their current workforce. As a result, the central bank is likely still on track for the ever-elusive soft landing, but we will continue to monitor economic indicators closely.

Europe Growth Problems: The EU’s largest economy is faltering, raising concerns about the region’s overall economic health as it strives to maintain tight monetary policies and curb inflation.

• The German economy may already be in recession, according to the Bundesbank, which warned that growth could “stagnate or decline slightly” in the third quarter. This grim outlook comes after the economy has narrowly avoided the label despite having economic contractions two of the last three quarters. Additionally, firms are struggling as this month Volkswagen decided to halt production at some plants and BMW lowered its 2024 sales and earnings targets. Although the Bundesbank remains hopeful that the downturn won’t be severe, it conceded that industrial activity remains a problem.
• Economic weakness in Germany could complicate the European Central Bank’s (ECB) efforts to maintain tight monetary policy to bring inflation down to target. Although the region has taken successful steps to reduce price pressures, concerns are growing that this progress is stalling, particularly in the services sector. Overall inflation has fallen from a 2022 peak of over 10.0% to 2.1% in August 2024. However, much of this decline is driven by a slowdown in goods inflation, with services inflation remaining stubbornly high at around 4%.

• The ECB must decide whether to prioritize containing inflation across the region or instead avoiding a severe economic downturn in Germany. Given Germany’s economic weight and influence within the EU, a significant downturn could force the central bank to take more aggressive steps to ease monetary policy. The effectiveness of these measures in combating inflation will depend on whether wage pressures, a major contributor to services inflation, show signs of easing. If worker pay were to accelerate, it would likely put upward pressure on inflation and this could weigh on the euro.

In Other News: Republican House Majority Leader Mike Johnson failed to push through a stopgap funding bill on Wednesday, raising the risk of a government shutdown. The Teamsters union announced it will not endorse any candidate in the upcoming election, signaling labor’s potential shift toward the populist wing of the Republican Party. Meanwhile, Taiwan expressed concerns that China’s increasing military activities are making it harder to detect signs of a possible invasion. The Bank of England decided to keep its rates unchanged at 5.0% for this month but signaled a willingness to ease policy gradually.

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