2023-10-30 06:06:06
In recent days, the yield on 10-year Treasury bonds has reached, and even exceeded for a time, the 5% threshold, the highest since 2007. Since the FOMC meeting on September 20, this is another increase of 50bps. The Fed can consider that the bond market is doing the work for it and therefore does not need to raise its key rates next week. This is the unanimous expectation. Certainly, the strength of consumption and employment maintains the risk of inflation but on the other hand, there are apprehensions regarding financial stability. Such a rapid rise in rates, accompanied by such great volatility, can weaken banks and other players in the financial system.
US Focus by Bruno Cavalier, Chief Economist and Fabien Bossy, Economist
US: bond market volatility
This week, the 10-year risk-free rate briefly exceeded 5%, before falling back towards 4.85%. Less than three years ago, it was less than 1%. The only case of such a rapid deterioration of the bond market is the “Volcker shock” in the early 1980s. Moreover, its volatility is at its highest since the 2008 crisis, if we put aside the transitional surge at the start of the pandemic and during the fall of SVB. This volatility can reinforce the market correction as highlighted by the BIS in a recent analysis of hedge fund positions(1). For its part, the Fed surveyed market professionals to prioritize the main risks(2). At the top of the list are monetary tightening, the fragility of commercial real estate, the re-emergence of banking stress, and tensions on the liquidity of Treasuries. All these risks are considered more severe than six months ago.
US: financial condition indicators
To date, however, there has been no major financial crisis. We might have expected worse given the scale of the rate shock. Earlier this year, the collapse of a few banks was certainly a serious warning, but calm quickly returned. Overall, the banking sector appeared better capitalized and more resilient than before 2008. Looking at the past, the indicators summarizing financial conditions are at a normal level, but this does not give any predictive signal. This is why the Fed has developed a new index aimed at measuring the impact of financial conditions on business conditions. In 2020 and 2021, the impact was positive. Since the start of 2022, it has become negative and has hardened further in recent months. The extraordinary figures for real GDP growth in Q3 2023 seem to refute this observation but we can also think that they occasionally exaggerate the strength of the US economy. In these future decisions, the Fed will not be able to ignore the risks weighing on financial stability, even if price stability, namely inflation returning to 2%, has not yet been completely restored.
US: GDP and components, annualized q/q variation
Economy
Au T3 2023, real GDP increased by 4.9% q/q at an annualized rate, vs. +2.1% in Q2. This is confirmation of the strength of household consumption expenditure during the summer following the weakness of the spring. Inventories, a volatile component of the national accounts, add more than one point of growth. Residential investment shows its first increase following nine quarters of contraction, a rebound that is difficult to extrapolate following the new surge in credit rates.
US: GDP and components, contribution to growth
In october, according to preliminary data, PMI surveys indicate a slight improvement in purchasing managers’ confidence: +0.2pt to 50.0 in the manufacturing sector, +0.8pt to 50.9 in services. These are not levels that we usually associate with a real GDP growth rate of nearly 5%.
October 25an agreement was reached between the UAW and Ford but the strike continues at the two other major auto manufacturers.
Monetary and fiscal policy
Complete data for fiscal year 2023 put the federal deficit at $1.7tr, or 6.2% of GDP, vs. $1.4tr in 2022. In reality, these two figures will have to be revised to take into account the rejection of the student debt cancellation plan, which will reduce the deficit from FY22 to $1tr and will raise that of FY23 to $2tr, or 7.5% of GDP. There is no case in the past where the federal deficit has doubled in a full employment economy. The interest expense amounted to $659 billion, up 39% year-on-year.
The October 25following three weeks of delay and uncertainty, a new Speaker of the House of Representatives was elected in the person of Mike Johnson. He was the fourth candidate nominated by the Republican Party, the three previous ones having failed to replenish the votes of their own party. The GOP is divided like never before on a host of issues, with the main divide separating those who believe the 2020 election was somehow “stolen” from Donald Trump and the others more legalistic. Mr. Johnson is one of the former president’s unconditional supporters, which undoubtedly earned him his victory, despite his lack of notoriety and parliamentary experience. In short, even entangled in a pile of legal cases, Donald Trump continues to exert considerable influence on the GOP.
Legislative work can resume. It is busy to say the least. Domestically, we must agree on the financing of federal spending for FY2024. The provisional agreement to avoid the layoff of hundreds of thousands of civil servants expires on November 17 (Focus-US of September 29: “Shutdown, instructions for use”). Joe Biden hastened to speak with the new Speaker to arrive at a more lasting solution. At the international level, Congress was presented by the White House with a request for aid of around $100 billion intended to support Israel and Ukraine. Regarding support for Israel, Mr. Johnson favors it, but earlier this year he voted once morest military aid to Ukraine.
To be continued this week
According to unanimous expectation, the FOMC meeting November 1st will result in a status quo. The next meeting is December 13 (futures give a 19% probability of a rate rise). The publication schedule is very busy: October 31home prices and the Conference Board Consumer Confidence Survey; November 1stin addition to the FOMC, construction spending, ISM manufacturing and the job openings report; the 3, the report on the labor market and ISM-services. Employment data will be scrutinized from all angles following last month’s surprise (a jump in payrolls of 336k).
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