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Question For The Fed: Where Is Waldo?
The risks to the Fed’s dual mandate are constantly changing. Its attempt to hit its inflation target is complicated by price pressures beyond the control of interest rates, and its attempt to hit on a federal funds rate that neither over-stimulates nor over-restricts economic growth is complicated by the elusive nature of this neutral rate. Today, Elias and Ed examine the forces with bearing on the Fed’s rate decisions since 2022. They also explain why they believe that the neutral federal funds rate has risen over recent years and the implications for monetary policy looking ahead.
ECONOMIC WEEK AHEAD: October 19 - 23
Last week’s inflation reports came in hot. September’s CPI rose 0.6% m/m, lifting headline inflation from 3.4% y/y in August to 3.7%. Core CPI rose 0.3% m/m, taking its y/y rate from 2.4% to 2.6%. Both topped expectations. PPI final demand jumped 1.3% m/m. That pushed its y/y rate to 6.3%, the highest since 2022. Retail sales rose 0.8% m/m, though just 0.2% excluding gas stations. Odds of a 25bps hike at the October 27-28 FOMC meeting fell from 22% before the CPI report to 17%, despite the hot inflation data. Fed Chair Kevin Warsh offered no signal on October's meeting at the IMF and World Bank annual meetings in Bangkok on Friday. “I don’t prejudge meetings,” he said. Odds of a December hike rose. We still expect the Fed to reverse the remaining two of last year’s three 25bps “insurance” cuts. Fed officials are now in their pre-meeting blackout period. This week’s data calendar is light, with earnings season taking center stage. Friday’s flash PMIs are the main US releases. The Fed’s Financial Stability Report and Canada’s federal budget are tentatively due Tuesday. Here’s more: (1) ADP & Unemployment Claims. ADP’s weekly employment reading (Tue) follows a rise in the four-week average to 24,750 for the week ended September 26, the highest since early June and up from a late-July bottom of 8,250 (chart). Initial jobless claims (Thu) follow last week’s 199,000, with the four-week average at 198,500 (chart). Continuing claims fell to 1,710,000 for the week ended October 2, matching their four-week average. The labor market continues to improve. (2) Flash PMIs. S&P Global’s flash M-PMI and NM-PMI for October (Fri) follow September readings of 55.9 and 58.8 (chart). The services prices component is worth watching after ISM’s NM-PMI prices-paid index jumped to 70.7 in September, the highest since July 2022. Flash PMIs for Australia and Japan (Thu) and for the Eurozone, Germany, France, and the UK (Fri) also land this week. September’s M-PMIs were 52.9 for the Eurozone and 52.1 for the UK. (3) Earnings. The earnings reporting season picks up this week. Netflix, GE Aerospace, and Northrop Grumman report on Tuesday. Tesla and Meta, the first of the Magnificent-7 to report, follow on Wednesday along with Lam Research, IBM, and Texas Instruments. Spotify, Bloom Energy, Western Digital, Lockheed Martin, and Blackstone report on Thursday. ASML and TSMC posted record Q3 results last week. ASML’s net sales rose to €11.7 billion from €9.3 billion in Q2, with the gross margin up to 57.5% from 54.0%. TSMC’s revenue jumped 50.9% y/y. Analysts’ consensus estimates imply Q3-2026 operating EPS growth for S&P 500 companies of 24.0% y/y (chart). (4) Global. China’s Q3 GDP (Mon) follows Q2’s 4.3% y/y growth (chart). We expect a moderate pickup in activity. China’s unemployment rate for September is also due, following August’s 5.2% rate. UK CPI (Wed) for September follows August’s 3.1% y/y headline and 2.6% core (chart). Rising energy and input costs point to a further pickup, with the input PPI up 8.2% y/y in Q2. Bank of England Governor Andrew Bailey speaks later that day. UK labor market data (Tue) and PPI (Wed) are also due. Canada’s CPI (Mon) for September follows August’s 3.0% y/y headline and 2.3% core (chart).
GLOBAL MARKET CALL: Downgrading 'Go Global' To Market Weight
We are downgrading the “Go Global” portfolio strategy from overweight to market weight and raising “Stay Home” (in the US) from underweight to market weight. Overseas earnings remain impressive, but the rallies in emerging market economies’ stock markets have been led by just a handful of AI-related stocks. Last week's rout in South Korea showed how vulnerable such concentration leaves these stock markets. Additionally, European economies look set to struggle as France's fiscal problems loom, and China's economy depends almost entirely on exports. Plus, the Middle East war could flare up again before or after the US midterm elections on November 3, keeping oil prices, inflation, and interest rates elevated. Here's more: I. Global Bonds The global bond rout took a breather last week. Yields fell in all eight major bond markets we track, led by the US (chart). The US 10-year Treasury yield fell 16bps to 5.08%, even as the CPI rose 3.7% y/y and the PPI jumped 6.3% in September. That suggests bond investors see these rates as attractive relative to their long-term inflation expectations. The spread between French and German 10-year yields has stabilized at around 137bps, near its recent high (chart). Spreads for Italy, Greece, Spain, and Portugal have eased slightly from their late-September peaks. Contagion from France has eased for now. But France's own fiscal risk premium hasn't. The National Assembly began debating France's 2027 budget on October 13. Meanwhile, Paris is burning! II. Global Stocks Brazil leads the country ETF rankings mtd, up 12.3% in dollars, ahead of next Sunday's presidential runoff (chart). South Korea is at the bottom, down 17.7%. The US is up 0.1%, ahead of the All Country World ex-US ETF, down 1.9%. Europe's share of the All Country World MSCI's market cap has fallen to 13.0%, from as high as 30.8% in 2007 (chart). It looks set to keep losing ground for a while. The US MSCI’s share has firmed to 64.8%, up from 62.4% in March. The Emerging Markets MSCI’s share has held at 12.1% despite the Korean selloff. The ratio of the US MSCI to the All Country World ex-US MSCI has turned up in recent weeks (chart). It remains below its early-2025 high. III. Earnings & Valuation The All Country World ex US MSCI's forward earnings is up 41.4% y/y, while forward revenues is up 11.0% (chart). The global economy is doing well. Overseas, earnings have far outpaced stock prices this year. The All Country World ex-US MSCI is up 10.5% ytd, while its forward earnings is up 35.9% (chart). Its forward P/E has dropped 18.9% ytd. The US MSCI's forward P/E is 19.1 versus 12.2 for the All Country World ex-US, a 57% premium (chart). US profit margins justify about half of it. The US forward profit margin is 16.8%, about a third higher than the All Country World ex-US's 12.7%. IV. China Focus China remains a source of deflation for the global economy through its massive trade surplus. Exports jumped 36.3% y/y in September to a record high (chart). The trade surplus was $133.5 billion. Semiconductor exports more than doubled during the first nine months of the year. Booming exports are the only reason China's economy isn't imploding. The domestic economy remains weak, weighed down by a rapidly aging population and a property debacle. The Shenzhen Real Estate Stock Price Index is testing a floor that has held since 2012 (chart). We would worry if it broke below that level. The stock market hasn't benefited from the export boom either, so Beijing appears to be propping it up again. Regulators met on Thursday to discuss stabilization measures, according to Bloomberg. They reportedly urged companies and state funds to buy shares and asked some investors to curb selling. Mainland A-shares, where Beijing's state-backed funds do most of their buying, held up into mid-2026 before turning down (chart). Offshore Chinese stocks have been falling since late 2025.
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