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Markets crap out again to close out horrific September and quarter

Driven by inflation and the Federal Reserve’s response to it, bears are multiplying while the bulls die out.

MANHATTAN (CN) — The third quarter of 2023 came to a sobering end Friday, but perhaps not quickly enough for investors after one of the worst Septembers in more than a decade.

By the week’s end, the Dow Jones Industrial Average, already down about 2,000 points this quarter, lost 860 points since last Friday. The S&P 500 and Nasdaq fell 107 points and 292 points, respectively, by the closing bell.  

Much of the market malaise is still being driven by the hawkish Federal Reserve and its decision to recently raise interest rates again by 1%. But slowing growth, distress in bond markets domestically and abroad, and the continued stress of Russia’s war in Ukraine have increasingly diminished investor optimism.

“The bear remains in control,” wrote James Vogt at Tower Bridge Advisors, noting that the strong labor market has actually hurt Wall Street. “It is clear that inflation has peaked, but it is not dropping fast enough for the Fed. Their ‘transitory’ mistake led to five quarters of rising CPI/inflation data. It could take another five quarters to get back to 2%.”

While equities were able to recoup some value early in the week, markets again plummeted after an announcement by the Bank of England that it would start purchasing 10-year bonds again to help stabilize the bond market there. The United Kingdom has come under fire in recent days for its market turmoil, in which economic uncertainty had caused a massive sell-off of government bonds.

Fortunately, the meager inflation data released this week shows some silver lining. On Friday, the U.S. Bureau of Economic Analysis noted that the personal consumption expenditures increased by $67.5 billion in August, with the PCE index rising by 0.3% and matching the consensus.

“Again, good news is bad news right now. The stronger our labor force continues to be, the most likely Fed officials keep pressing the needle and raising interest rates,” Vogt wrote. “Every 25 [basis points] higher equates to an increasing likelihood of a policy mistake and a deeper recession, as opposed to the soft landing everyone is hoping for.”

The PCE data also show that the U.S. economy is likely to squeak by with some growth in the third quarter after seeing the economy shrink for the past two. But it is increasingly likely that a recession has been baked into the economy for 2023, particularly since inflation likely is not dropping fast enough to appease the Fed.

“With real spending and real disposable personal income up on the month in August, the economy wasn’t in recession, but it clearly is slowing,” said Bill Adams, chief economist for Comerica Bank in Dallas.

Adams noted that job growth last month was disproportionately in part-time jobs, which has restrained income growth. Further, the BEA’s downward revision to the personal savings rate shows households are under even more financial pressure from inflation. The personal savings rate is at 3.5%, down from 4.7% in January.

“Consumers are likely to pull back on discretionary spending in the fall and winter, especially in categories where they splurged in 2020-2021, like electronics, home furnishings, and athletic equipment,” Adams said.

For now, fortunately, consumer sentiment has been inching back up. On Friday, the University of Michigan reported that its consumer sentiment index increased slightly, according to its final September reading. It is still above the bottom back in June of 50 points, and the index is nearly 20 points lower than a year ago.

“Consumers welcomed the slowdown in inflation last month, but they show signs of uncertainty over the trajectory of the economy,” Joanne Hsu, chief economist of the survey, said in a statement. “The continued war in Ukraine, the prospect of higher energy costs in Europe, and climate disasters all have the potential to exacerbate inflation in the U.S., and consumers will quickly notice any pass-through to rising prices.”

Unemployment, which hasn’t been a major issue recently, has also gotten better, with the Labor Department reporting that initial jobless claims fell to under 200,000, a five-month low and far lower than analysts had predicted. Continuing claims also fell to 1.3 million, nearly 40,000 less than experts had forecast.

“The imbalance between the supply and demand for workers, which is putting upward pressure on wages, is a key factor behind the Fed’s plans to continue raising interest rates,” wrote Nancy Van Houten, analyst at Oxford Economics, who, like many other analysts, forecasts another 1.25% in interest rate hikes by the Fed by the year’s end.

“We don’t expect [unemployment] claims to fall much from current levels, but don’t look for a spike in claims anytime soon either,” she wrote. “We expect employers will slow the pace of hiring workers well in advanced of any significant layoffs, which we don’t anticipate until next year.”

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