MANHATTAN (CN) — Equities took another dip this week as investors grappled with mixed data showing improving inflation but cooling spending, as well as another impending government shutdown.
While nuggets of data showed both inflation and consumer spending are dropping, the major news for investors this week was the likelihood of a government shutdown. The impact of a shutdown would likely be minimal for the economy, but it could have a ripple effect on how the Federal Reserve approaches interest rates, and thus how investors approach their portfolios in 2024, experts say.
“In the near-term, a shutdown will disrupt the flow of government statistics, making the job of a data-dependent Fed more difficult,” economist Nancy Van Houten at Oxford Economics wrote in an investor’s note. “An extended data drought would lend further support to our call for no additional rate hikes.”
By the closing bell on Friday, the outlook for a bipartisan spending deal seemed bleak, and markets were even bleaker. The Dow Jones Industrial Average shed 455 points for the week, while the S&P 500 lost 32 points and Nasdaq gained only 10. For the month, the Dow has lost 1,368 points, the S&P 242 points, and the Nasdaq 908 points.
Other data points this week did little to help bolster markets. On Friday the U.S. Bureau of Economic Analysis released its inflation report for August, showing the personal consumption expenditure price index gained 0.4% last month.
However, the core inflation reading, which excludes food and energy, increased by just 0.1%, less than expected and continuing its monthslong downward trend.
Experts hope the Federal Reserve latches onto the fact that the three-month annualized core inflation rate is now barely above the 2% target set by the central bank. “The data also reinforce our view that the Fed’s inflation projections are far too pessimistic,” wrote Andrew Hunter, deputy chief U.S. economist at Capital Economics, forecasting a core inflation will drop “well below” the Fed’s 3.7% projection by the end of the year.
The BEA also revised its estimate of gross domestic product for the second quarter, showing a gain of 2.1%, in line with its last estimate for that period. The good news is that is solidifies the theory that the worst-case scenario — stagflation — has been avoided.
That doesn’t mean consumers are overjoyed, though. On Friday, the University of Michigan released its monthly consumer sentiment index, showing a slight drop this month from 69.5 to 68.1. This is the second straight decline after the index had picked up gains in June and July and keeps the index in or near recessionary levels.
“Consumers are understandably unsure about the trajectory of the economy given multiple sources of uncertainty, for example over the possible shutdown of the federal government and labor disputes in the auto industry,” said survey Chief Economist Joanne Hsu. “With consumers already feeling tentative about the state of the economy, the consequences of a lengthy shutdown could be severe.”
Analysts see the index as a portent for further wallet tightening. “Consumer confidence no longer has a close relationship with actual spending,” Micheal Pearce, lead U.S. economist at Oxford Economics, wrote in an investor’s note.
Pearce noted consumers have exhausted their excess savings — the personal saving rate hit 3.9% in August, compared with 5.3% in May — and that consumption will likely continue to fall over the next six months, as will sentiment. “It’s still uncertain how much further the boost from excess savings has left to run, but we expect a slowing labor market to weight on incomes growth and push up precautionary saving, weighing on consumption growth over the coming months,” he wrote.
Between the dropping consumer sentiment and lower savings, it would appear that consumer spending could be further on the wane. As a result, many experts still predict a short recession rather than a completely soft landing, but a soft landing is still a possibility.
“We believe that a recession is inevitable, but we have been surprised by the resilience of the consumer,” said Chris Zaccaralli, chief investment officer at the Independent Advisor Alliance. “We think the economy and market have further to run and that the recent equity weakness is just a pullback in a bull market, and not the beginning of the next bear market.”
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