Weekly Investment Update (11/17/2023)

Our next Weekly Investment Update will be published on December 1. We wish you and your families a warm and joyful Thanksgiving.

This Week’s Views and Positioning

This week’s below-consensus inflation reading underscores the notion that incoming data, rather than Fed-speak, is the key market driver. Inflation remains above target and is largely being held higher by shelter costs. Excluding the shelter component, the 3-month core CPI reading is just under 2%. Asking rents are quickly falling, which should pull shelter costs down in the coming quarters.

We still do not believe the Fed has much incentive to be proactively dovish, particularly as key macroeconomic indicators give mixed signals about the underlying strength of the economy. For example, retail sales contracted in October by 0.1% month-over-month but are faring better than the 0.3% contraction that was expected. The latest report also included upward revisions to the September reading. Taken together, there is evidence of economic slowing, but U.S. consumption appears stable. At the same time, companies such as Walmart have highlighted “softening in the back half of October.” Given these crosscurrents, we expect a more “wait and see” communication at the Fed’s next meeting.

We maintain an overweight to equities and longer duration bond allocations as we expect to see continued evidence of a cooling economy. Our base case remains that the progression of falling inflation and a controlled slowdown should be supportive of risk assets.

Inflationary Pressures Cool in October

What is happening: Both headline and core CPI inflation came in below consensus expectations for the month of October. Headline CPI was flat month-over-month, the lowest reading in 15 months, driven by lower energy prices, pushing the year-over-year rate down to 3.2% in October from 3.7% in September. Core CPI increased 0.2% month-over-month, below the 0.3% consensus expectation, bringing the year-over-year core rate down to 4.0% in October from 4.1% in September. Accelerating shelter costs continue to be the largest driver of monthly increases for core CPI, though at a slower pace compared to last month. Core services excluding housing, a key metric for the Federal Reserve given its correlation to wages, cooled in October after a large gain in September.

Why it matters: After the softer than expected inflation print, futures markets have, for the first time this rate hiking cycle, priced out any future rate increases and pulled forward expectations for interest rate cuts to May from June. We believe that the Federal Reserve has completed its hiking cycle, though it will likely push back against the market’s prediction for earlier rate cuts. The path toward 2% inflation is unlikely to be linear, and underlying inflation remains well above the Federal Reserve’s target. The softer inflation print, along with recent company commentary and surveys depicting a cooling economic environment, has pushed yields lower and benefited equity and fixed income returns over the past month. Bessemer’s All Equity Model Portfolio is overweight growth-oriented sectors that should fare better in a falling yield and slowing economic environment.

U.S. Government Avoids Pre-Thanksgiving Shutdown, Pushing the Fiscal Fight to 2024

What happened: Congress passed a continuing resolution (CR) bill to extend government funding at current levels, effectively avoiding a government shutdown on November 17. The legislation comes with no other policy changes attached, despite initial proposals to include social priorities or spending cuts. A bill for supplemental aid to Israel and Ukraine is running on a separate track; however, it faces complications as Republicans are aiming to tie the bill to immigration reforms to protect the southern border. The ongoing political gridlock in Washington was a key reason that Moody’s downgraded the U.S. credit outlook from stable to negative this week. We note that Moody’s remains the only major credit agency that has maintained a AAA rating after the Fitch downgrade in August and the S&P downgrade in 2012.

Why it matters: The continuing resolution allows the government to avoid a pre-Thanksgiving shutdown, effectively pushing the budget fight into 2024. As it will be increasingly difficult for Congress to pass another short-term extension, the risk of a government shutdown in January has risen. Looking ahead to next year, we remain mindful of risks to the nation’s fiscal strength given the current political polarization in Congress. Still, we believe that U.S. funding cost risk is well mitigated by the critical and central roles of the U.S. dollar and Treasury market within the global financial system. While supply and demand imbalances in the Treasury market have been one factor impacting the term premium, the outlook for the economy and, in turn, the Fed remains the more important driver of yields, as evidenced by the moves seen in bond markets this week.