US - Mixed signals amid strong data

Economic data has come in strong over the past month, rounding off what is likely to have been a robust performance of the economy in Q3: when the national accounts are released on Thursday, growth is likely to be at a well-above trend rate of 4-5% q/q annualised (our forecast is 4.3%). Much of the above-trend growth is likely to come from volatile inventories and net exports components, but underlying growth has also been surprisingly strong, with private consumption expected to have expanded by 3.8% annualised. Underpinning this strength is an apparent rebound in jobs growth, with three month moving average payrolls growth picking up to 266k in September from 189k in August. We use the word ‘apparent’ to describe this, because economic data in the US has been highly revision-prone in the post-pandemic era. Indeed, in our last Monthly, we noted the significant downward revisions to jobs data which pointed to a clear slowing in the labour market. Data reliability has been impacted by a falling response rate since the pandemic, making it more difficult to interpret incoming data than in the past. Response rates increase over time meaning that subsequent revisions to the data are still reliable, but this implies that we should not put as much weight on preliminary data releases as in the past.

If the incoming data is indeed painting a misleadingly strong picture of the economy, one could point to more qualitative indicators as evidence. Last week, the Fed’s October Beige Book indicated “little to no change in economic activity since the September report,” consistent with the subdued growth assessments seen earlier this year. Alongside weak economic growth, the Beige Book also suggested businesses were struggling “to pass along cost pressures because consumers had grown more sensitive to prices,” and that this is in turn pressuring profit margins. CPI inflation in September was a little firmer than expected, with headline inflation holding at 3.7% y/y and core inflation edging down to 4.1% from 4.3% (we had expected a slightly bigger drop to 4.0%). However, pipeline inflationary pressures remain benign, with for instance rents on new leases growing at a subdued pace, and recent wage growth readings now not far above the pre-pandemic pace.

The Fed is – understandably – adopting a cautious, non-committal stance given the continued conflicting signals we are getting from the economy. The significant run-up in bond yields, with the 10y Treasury yield topping 5% this week, also represents a major tightening of financial conditions that is probably equivalent to a couple more rate hikes. Despite this, the pushback from Fed officials has so far been restrained. Still, the Fed looks fairly certain to keep policy on hold at next week’s FOMC meeting, and a December hike also looks unlikely, barring a major upside surprise to labour market and/or core inflation data next month. How soon the Fed pivots to more dovish communication will depend on how the conflict in the data and the qualitative read on the economy resolves itself over the coming months, with our base case continuing to see a substantial slowdown in Q4.