Macroeconomic overview for September 2024

Eugeniu Kireu, CFA

Oct 21, 2024

In September, the most important macroeconomic event was the reduction of the interest rate in the US from 5.5% to 5%. It is significant primarily because the rate had not been reduced for 2.5 years and remained at a peak level for this growth cycle for almost 14 months. This period turned out to be significantly longer than analysts expected and almost as long as the period of maintaining a high rate before the financial crisis of 2007. Then it rose to 5.25% and stayed there only 26 days longer than in the current cycle of monetary policy tightening. The reduction in both September 2007 and September 2024 was immediately 50 basis points, but the conditions under which the reduction occurred are noticeably different. By September 2007, the mortgage crisis had been unfolding for at least six months, housing prices had already fallen significantly, and a significant number of subprime lenders had gone bankrupt. Currently, there are no acute or sufficiently large-scale problems in the financial system that could indicate an unfolding credit crisis, and the rate reduction is occurring in conditions of fairly stable economic growth and the labor market.

Inflation in the US remains somewhat above the Fed's target and stands at 2.4% for the twelve months ending in September. Core inflation is still relatively high — at 3.3% — but stable. The disinflation observed in the middle of the year has paused, although the contribution of energy to the overall price level growth remains negative. The US economy added 254,000 jobs, exceeding most analysts' forecasts. The unemployment rate also fell to 4.1%, which does not yet confirm the Fed's concerns about the indicator rising to 4.4% by the end of the year.

At the same time, the level of confidence among investors and analysts in labor market statistics and its relevance is significantly lower than before. This is caused by many factors, including frequent downward revisions of indicators, significant illegal migration to the US, and the predominance of job growth in the public sector (over the past year, the public sector has created new jobs at a rate 1.6 times greater than the private sector). At the same time, despite the continued increase in the number of jobs, wage growth is not very high, considering the increased labor productivity. Over the past year, compensation increased by an average of 4%, which is below the combined growth of inflation and labor productivity (the estimate for the second quarter showed a productivity increase of 2.7% over the previous 12 months). This means that despite the growing demand for labor, there is no reason for inflation to accelerate due to wages.

Simultaneously, estimates show that excess household savings are depleted, and the credit burden has generally returned to levels comparable to the period before the pandemic. While real interest rates remain relatively high, lending volumes are unlikely to increase enough to cause an acceleration in aggregate demand and inflation growth. The stability of aggregate supply is less predictable due to the significant influence of global economic and political factors. At the same time, the weakness of the global economy compared to the US does not provide reasons to expect a sharp increase in demand for raw materials and a corresponding rise in prices. China's economy, despite significant monetary and fiscal stimuli, still faces serious problems. Foreign direct investment is rapidly declining. Housing prices are falling, and the stock market, despite recent growth, is still trading very low by historical standards. New home prices in September fell 5.3% below the level of a year ago, and there is no clear reversal in their dynamics, even considering government incentives. Meanwhile, problems in the housing market are significantly more important for the Chinese, whose capital, unlike US residents, is primarily concentrated in real estate rather than stocks or other securities. Moreover, there are no strong reasons for inflation to rise due to a supply shock. Supply chains are not disrupted, and local military conflicts have not yet reached the level of escalation that would inevitably lead to problems in energy or food markets. The situation around Taiwan, despite the tension due to China's military exercises, remains without clear escalation from any of the parties involved in the confrontation. North Korea's actions on the border with South Korea, such as blowing up border roads, do not contribute to de-escalation but are unlikely to indicate any clear military threats to the latter.

As a result, when discussing the prospects of the US economy and inflation, it can be said with a certain degree of confidence that as long as real rates are quite high and there are no clear shifts in the balance of aggregate demand and supply, inflation, albeit slowly, should continue to decline. Of course, this state heavily depends on how all the aforementioned internal and external economic factors will change. There are significant risks that a change in the US president could lead to a change in the macroeconomic status quo, but both the outcome of the elections and the possible extent of fulfilling campaign promises cannot be predicted with sufficient certainty. The same applies to the escalation of military conflicts and the global financial system as a whole, part of which is China, experiencing serious structural problems.

Simultaneously, risky assets, especially in US markets, remain very expensive by historical standards. Credit spreads have hardly moved from levels close to historical lows, and the risk premium in the stock market, according to various estimates, is either significantly lower or near the levels preceding the last global economic crises. The maintenance of high rates due to the resilience of the US economy rather increases the risk of its hard landing due to the intensification of problems in weak sectors of the economy and the financial system. Companies with poor credit quality, which actively borrowed at zero interest rates in 2020 and 2021, will soon have to massively refinance debt. Maintaining high rates could be a significant problem for both companies and holders of such debt. The high cost of risky assets with simultaneously high risk-free real rates by the standards of recent decades and the presence of events that could become a catalyst for changing the current paradigm and correcting asset prices, in my opinion, rather support the idea of reasonable caution than the fear of missing potential benefits.