Financial News for the Week of October 20th, 2023

The steep ascent of U.S. Treasury yields continued unabated this week, as markets revised their expectations for yields, particularly over the longer term. The persistent political dysfunction in Congress amid rising deficits and heightened geopolitical tensions is likely playing a role in the increase in the term premium, which has recently contributed to the higher 10-Year yield. The term premium reflects the added compensation investors require for the unknowns associated with holding longer-term government debt. The 10-Year Treasury yield is now just under 5%, its highest level since before the Global Financial Crisis (Chart 1). Equities in turn fell this week, with the S&P 500 down 1.8% as of the time of writing.

Outside of financial markets, the real economy has seen divergent trends between economic sectors depending on their sensitivity to interest rates. The housing market softened further in September to reach a 13 year low, reflecting the strain of higher mortgage rates (see here). While existing home inventory levels improved on the month, supply remains low, which continued to place upward pressure on housing prices. Low resale listings have in turn increased the demand for new units, but elevated rates remain a headwind to homebuilding activity as well. While housing starts rose in September, they remain well below year-ago levels, primarily resulting from weakness in the more rate-sensitive multi-family segment.

Despite higher interest rates, the health of the American consumer has remained robust (see here). Retail sales growth in September more than doubled expectations. Somewhat surprisingly, the most rate-sensitive segment of retail sales (Automobile & other motor vehicle dealers) saw its strongest growth in four months in financial news. However pent-up demand from the extended shortage of vehicles in previous years continues to be a factor. But, even excluding the more volatile categories, the retail sales “control group” was very strong on the month. All in all, the resilience of the consumer has been a key growth contributor in 2023.

In terms of what this means for interest rate moves, we heard remarks from nearly every member of the FOMC this week, including Chair Powell. The balance of opinion was skewed towards maintaining a wait and see approach given the positive progress that has been made on inflation thus far, which pushed market pricing for a hold at the next meeting on November 1st to a virtual certainty (Chart 2). However, Powell also noted that additional evidence of persistently above trend growth or tightening labor market conditions could put inflation progress at risk and warrant further policy tightening. We currently expect that the resilience of the U.S. economy will lead to one last interest rate hike, but the recent tightening in financial conditions makes it a close call.

Next week we will see the advance estimate for third quarter GDP growth, which is expected to show eye-popping growth. Perhaps more importantly, the September consumer spending data will show how momentum is looking heading into the fourth quarter, along with the Fed’s preferred inflation metric. A moderation in both metrics would be welcome news for the Fed.

 

Andrew Foran, Economist | 416-350-8927