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December 4, 2023

November 2023: Inflation trends down, Fed holds steady

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November at a glance

  • Markets rallied in November as investors grew more confident that continued easing in inflation would mark the peak of the current interest rate increase cycle.
  • Equity markets surged in November with US technology stocks again leading the way.
  • The Fed kept policy rates unchanged as expected but longer term interest rates fell, boosting fixed income returns.
  • Economic activity remained strong buoyed by consumer spending, but household finances have deteriorated.

Continued easing in inflation, falling interest rates, and solid economic growth fueled a rally in stocks and bonds in November. The core Personal Consumption Expenditures price index, the Fed’s preferred gauge of inflation, was up 3.5% in October from a year earlier, down over a percentage point since this past summer.1 The market seems to interpret the progress on inflation as a sign that the Fed is finished with interest rate increases, but Chair Powell continues to temper those expectations, saying at a speech on November 9th, that he was “gratified by this progress but expect that the process of getting inflation sustainably down to 2 percent has a long way to go”.2 Still, while the Fed held short-term interest rates steady, longer term rates fell notably over the month with the 10-year Treasury yield ending the month at 3.84% after topping 5% in October.3

On the other side of the Fed’s dual mandate, economic activity remained strong. The unemployment rate in October was 3.9%, little changed from September although job growth did show some signs of moderating.4 Third quarter GDP was revised upwards to a robust 5.2% annual rate, led by still accelerating consumer spending.5 It is apparent that investors have priced in no further interest rate increases (and indeed several rate decreases in 2024) as well as a “soft landing” for the economy. The bullishness on the economic trajectory seems to be most at risk of disappointing investors as the lagged impact of tighter monetary policy begins to bite. To that end, the path of consumer spending will be the key metric to watch.

A broad rally in equities

  • Equity markets rallied in November, with all major indices posting returns above 7%.6
  • The NASDAQ led again, but the Dow surged to end the month reaching its highest level since January 2022.
  • Small cap stocks rose both in the US and internationally and are now positive for the year.7
  • Cyclical sectors fared best in November.8
  • Technology stocks led, rising 12.73% for the month.
  • Real Estate stocks jumped 12.27% but are up just 0.28% for the year.
  • Energy stocks fell 1.65%, the only sector posting negative returns for the month.
  • Defensive sectors (healthcare, utilities and consumer staples) rose for the month but remain negative for the year.
  • Equity returns were equally strong outside of the US, with developed international stocks now up over 10% for the year.9

Equity returns: November and year-to-date 2023

Source: S&P Dow Jones Indices10, NASDAQ11

Falling rates lifts all bonds

  • The Fed held policy rates steady, but longer-term rates fell during the month.12
  • Fixed income returns were strongly positive with all segments rising over 2% except ultra short term Treasury bills.13
  • Preferred stocks rose the most for the month and now lead for the year followed closely by high yield bonds.14
  • All fixed income segments are now positive for the year.15

Fixed income returns: November and year-to-date 2023

Source: S&P Dow Jones Indices

Soft or Hard Landing? Eyes on the Consumer.

With just over two-thirds of US GDP coming from consumption, the trajectory of broad economic activity is especially dependent on consumer spending.16 The latest personal consumption expenditures index for October showed a 5.3% increase from a year earlier, just above the average rate in the 2000s and not too far off the most recent estimate for Q3 GDP growth.17 The expenditures chart shows the massive distortion from the 2020 pandemic and aftermath with the decline during the lockdown and the subsequent rebound driven by the flooding of the economy with liquidity from monetary and fiscal policies. The last several years have seen a steady return to more normal levels of spending as stimulus programs have ended and consumers work off their inflated levels of savings. A key question is whether consumers can keep up this level of spending with a greatly reduced savings buffer. 

Personal Consumption Expenditures: Change from year earlier

Source: Bureau of Economic Analysis, Personal Income and Outlays

An interesting chart from Apollo Global Management, shows, for the last six recession periods, how much household savings rose above (in “excess” of) the trend in the years before each recession.18 In any recession, monetary and fiscal stimulus measures are put in place to help offset declines in income and spending, but the last three recessions, especially during the 2008 Global Financial Crisis and the 2020 Pandemic, are notable for how much cumulative excess savings were created. In the first 18 months after the 2020 recession, stimulus spending created a tremendous amount of money for households that allowed them to keep spending while also building up savings (the red line in the chart). That money has been increasingly drawn down and the current level suggests the excess savings supporting the resilient levels of consumer spending in the past several years may be running low.

Source: Bureau of Economic Analysis, Apollo Global Management

This measure of excess savings, while declining, remains a positive contributor to the relatively robust spending we still see, but other measures are starting to show challenges for consumers. Many of these paint a picture of worsening household balance sheets. In addition to spending from the savings created from monetary and fiscal stimulus policies, consumers have increasingly used credit to maintain spending levels. Credit card balances are up 15.7% from last year’s level, well above the 3.5% annual rate of increase seen in the years before the pandemic.19 As those balances have risen, along with higher interest rates and inflation, delinquencies on credit card bills have increased sharply.20 The delinquency rate is still not as high as during the Global Financial Crisis, but the trend raises concerns about the ability of consumers to keep spending at current levels.

Credit card delinquency rate: Over 90 days

Source: New York Fed Consumer Credit Panel/Equifax

The soft landing scenario requires consumers to keep spending. While the measures shown above raise questions about that outcome, neither measure is at a level that is worse (the lowest cumulative savings or higher delinquencies) than in past recessions. Tight labor market conditions and generally rising wages may continue to provide enough support to consumer spending to allow the US to avoid a recession and justify this year’s rise in risk asset prices. Deterioration in the labor market as well as any further worsening in consumer finances would certainly be enough to tip the economy into recession and force a decline in asset prices as investors reconcile a hard landing reality with soft landing expectations.

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1 https://www.bea.gov/data/personal-consumption-expenditures-price-index-excluding-food-and-energy
2 https://www.federalreserve.gov/newsevents/speech/powell20231109a.htm
3 https://fred.stlouisfed.org/series/DGS10
4 https://www.bls.gov/news.release/empsit.nr0.htm
5 https://www.bea.gov/data/gdp/gross-domestic-product
6 https://www.spglobal.com/spdji/en/index-family/equity/
7 https://www.spglobal.com/spdji/en/index-family/equity/
8 https://www.spglobal.com/spdji/en/index-family/equity/us-equity/sp-sectors/#indices
9 https://www.msci.com/end-of-day-data-search
10 https://www.spglobal.com/spdji/en/index-family/equity/
11 https://www.nasdaq.com/market-activity/index/comp/historical
12 https://www.spglobal.com/spdji/en/index-family/fixed-income/
13 https://www.spglobal.com/spdji/en/index-family/fixed-income/
14 https://www.spglobal.com/spdji/en/index-family/fixed-income/
15 https://www.spglobal.com/spdji/en/index-family/fixed-income/
16 https://fred.stlouisfed.org/series/DPCERE1Q156NBEA
17 https://fred.stlouisfed.org/series/PCE
18 The measure used in the chart from Apollo is based on research from the Federal Reserve Bank of San Francisco https://www.frbsf.org/economic-research/publications/economic-letter/2023/may/rise-and-fall-of-pandemic-excess-savings/
19 https://fred.stlouisfed.org/series/RCCCBBALTOT
20 https://www.newyorkfed.org/microeconomics/hhdc/background.html
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