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Weekly Economic and Financial Commentary: Perfect Example of He Said, Xi Said

U.S. Review

Despite Market Jitters, Fed to Raise Rates in December

  • An ephemeral trade truce, the inversion of the front-end of the yield curve and a softer than expected jobs report fueled fears of the economy slowing. But, with economic data this week suggesting a relatively healthy economy, we still expect the Fed to raise rates at its meeting on December 19.
  • The ISM manufacturing and non-manufacturing surveys point to robust activity. Nonfarm payrolls rose just 155,000 in November, and the unemployment rate held steady at 3.7%. But, while this report points to some softening in the labor market, we note that other measures suggest the overall jobs picture remains relatively strong.

Despite Market Jitters, Fed to Raise Rates in December

The front-end of the yield curve inverted this week, with two- and three-year Treasury yields rising above the five-year yield. Given that many analysts view an inversion as an omen for an economic downturn, this week’s inversion brought heightened sensitivity among markets to the increased probability of a recession on the horizon. We note, however, that while the yield curve has inverted prior to each recession since 1970, it has done so at varying degrees of lead time–from 8-23 months. Also, the spread between the twoand 10-year Treasury yields, a more widely recognized spread, has flattened recently, but has not yet inverted.

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Given that we are in the tenth year of the current expansion, which is the second longest on record, the late-cycle dynamic that this inversion suggests is not wholly surprising. Coincident measures of growth remain healthy but have come off the boil recently, while some forward-looking measures of growth have weakened. We look for a moderation in economic growth over the next two years, but are not forecasting a recession. Even as the Fed has moved away from a pre-determined policy path and become more data dependent, we do not expect this inversion to deter it from raising rates at its December meeting.

Economic data this week suggest a relatively healthy economy. One area of uncertainty continues to be trade turmoil between the United States and China. A meeting between President Trump and President Xi at the G-20 summit resulted in a 90-day ceasefire to allow for negotiations. While you can find our full analysis of the agreement in our International Review section on Page 4, here we highlight this temporary truce has not added certainty to the domestic outlook. Markets turned bearish this week as the potential for further escalation remains, while producers continue to feel the sting of tariffs in the form of higher input costs.

Fresh data from the Institute for Supply Management (ISM) this week pointed to robust activity in both the manufacturing and nonmanufacturing sectors in November. The manufacturing prices paid component fell sharply, while the non-manufacturing measure continued to trend higher. The anecdotal evidence from respondents of both surveys nonetheless suggests that tariffs are having a wide-ranging impact across industries, such as higher input costs weighing on producers. The manufacturing and nonmanufacturing surveys reported generally strong orders and rising backlogs. Both employment components remain at lofty levels, which was partially evident in this morning’s nonfarm payrolls release for November, with manufacturing adding 27,000 jobs.

But, nonfarm payrolls missed expectations in November, adding just 155,000 jobs over the month and with revisions to the prior two months also subtracting 12,000 jobs, today’s report points to some softening in the labor market. Other data suggest that the overall job picture remains relatively strong. Both ISM employment components remain high, consumers’ views of the availability of jobs continues to improve and small business hiring plans remain while job openings remain at record highs. We still anticipate the Fed will raise rates at its December meeting.

U.S. Outlook

Consumer Price Inflation • Wednesday

CPI inflation picked up in October on the back of higher energy costs, but the boost is expected to be unwound in November. Gasoline prices according to AAA fell 11% over the month and likely offset price hikes in other categories, keeping headline inflation flat. Excluding food and energy, inflation is expected to rise 0.2%, nudging the year-ago rate back up to 2.2%. The dollar’s strength is helping to keep a lid on goods inflation despite recent tariffs, while services inflation has moderated a touch recently amid softer shelter and medical care pricing.

We expect the pullback in headline inflation to have no bearing on the Fed’s rate decision for December. A softer-than-expected print for core inflation would also be unlikely to deter the Fed from going ahead with its widely-telegraphed hike