Slowing Services Sectors Drive Dovish Sentiments: Sep. 29, 2023

As a stormy month for equities and bonds draws to a close, markets are breathing a sigh of relief today on cooler-than-anticipated inflation readings from the US and the euro area. Stocks are on track for a third consecutive daily gain as investors dial up bets on both the Federal Reserve and European Central Bank being done with hikes. Market players are tilting their focus to how long both central banks will sustain higher interest rates and the context for interest rate cuts next year. The coast is barely clear, however, with a US government shutdown expected as soon as tomorrow night possibly, while auto workers strike against the Big Three automotive companies for sharp compensation increases. 

US Inflation Continues to Ease

In the US, August headline and core PCE price indexes rose 0.4% and 0.1% month over month (m/m) in August, according to this morning’s release of the Personal Income and Outlays report from the US Bureau of Economic Analysis. The results fell below projections of 0.5% and 0.2% and depicted slowing inflation. Results differ when compared to July, however, with headline accelerating from 0.2% while core inflation decelerated from 0.2%. The primary culprit for this discrepancy is the drastic rise in energy prices, which climbed 6.1% in August. Services slowed down significantly as consumers cut back on spending, with prices decelerating from a 0.5% growth rate in July to 0.2% last month. Durable goods prices fell for the third consecutive month, but the pace of decline slowed from -0.7% to -0.3%. Still, the core PCE price index is running at a rate of 3.9% year over year (y/y), almost double the Fed’s 2% target. Consumer spending and income both rose 0.4% in nominal terms and were essentially flat in real terms (consumer spending minus 0.4% inflation) and in line with expectations. Compared to July, spending slowed from 0.9% while income accelerated from 0.2%.

Services Prices Drop in Europe

Euro inflation also helped market sentiment, with the September headline result rising only 0.3% m/m and 4.3% y/y, respectively, better than estimates calling for 4.5% y/y. Core inflation also performed better than anticipated, with the 4.5% figure coming in short of the anticipated 4.8% rate while rising only 0.2% m/m. Driving the overall deceleration was a sharp 0.9% decline in services prices. Industrial goods, energy, and food, alcohol and tobacco rose 2.2%, 1.4%, and 0.1% during the period. 

Markets are adding to gains from the previous two days on positive inflation news on both sides of the Atlantic. Rate-sensitive technology is leading the major indices with the Nasdaq Composite up 0.8% while the S&P 500, Russell 2000, and Dow Jones Industrial Average are up by 0.4%, 0.2%, and 0.1%. All sectors are higher except for energy and health care, which are down 2% and 0.2%. Consumer discretionary and technology are leading with gains of between 1.1% and 1.4%. Bond yields are subdued on expectations of lighter central banks, lower oil prices, and deteriorating momentum in services spending. The 2- and 10-year maturities are down 2 and 5 basis points (bps) each to 5.04% and 4.52%. The dollar is higher on quarterly rebalancing, however, as it gains against the pound sterling, Canadian dollar, yen, and yuan, while it weakens relative to the franc, euro, and Aussie dollar. Crude oil is lower on the back of some profit-taking, with WTI down 88 cents to $90.89 per barrel.

Equity Gains Occur as Government Shutdown Nears

In Washington, the House of Representatives passed four of 12 spending bills required for funding the government, but in the process moved further away from what Democrats may approve, increasing speculation that a shutdown will occur starting this Sunday. A handful of conservatives continue to insist that spending cuts be included in the fiscal year budget and oppose a temporary spending measure. With House Speaker Kevin McCarthy having a narrow majority among Republicans, he will likely need Democrats to support the funding measures but gaining approval from the party is likely to provoke opposition from the hardliners. The Senate is also working on a stopgap funding measure, but it is unlikely to gain support from House Republicans.

Consumer Brands Generate Mixed Results

While higher costs of living are crimping many consumers’ capacity for spending, Nike and Carnival have just reported favorable quarterly results.

For the fiscal quarter that ended August 31, Nike revenues grew 2% y/y to $12.94 billion but missed the analyst consensus expectation of $12.99 billion, while its gross margin decreased from 44.3% to 44.2%. Nike says higher product costs and currency exchange rates hurt gross margins. The 44.3% result, however, substantially beat the consensus expectation of 43.7%, sending Nike stock’s price up more than 10%. Nike said sales were strong in all regions except for North America, where sales dropped 2% y/y. In a familiar trend among retailers, Nike’s inventory dropped 10%. While some industry analysts are concerned about the impact on consumer spending when student loan payments resume next month, Nike has maintained its full-year guidance of revenue growth in the mid-to-single digits, and gross margin expansion of 1.4 to 1.6 percentage points.

Cruise ship operator Carnival Corp. also posted better-than-expected results with its quarter EPS of $0.86 sailing past the analyst consensus estimate of $0.76, and with its all-time high revenue of $6.85 billion beating the estimate of $6.7 billion. For the same quarter last year, Carnival generated a negative EPS of $0.65 and revenue of $4.35 billion. Carnival also reported strong booking volume, which it said has positioned the company to drive its pricing higher, which will generate yield improvement next year.

A Silver Lining in Weakening US Consumption

A slowdown in services spending and decelerating prices are important for tackling inflation but they also pose problems to the US growth outlook. Yesterday’s second-quarter GDP revision downwardly adjusted consumption from a 1.7% growth rate to only 0.8% as many millennial Americans are due to resume student loan payments. The silver lining, however, is the strength of the US labor market and the desire for businesses to continue expanding against the backdrop of tight hiring conditions. Those conditions will help the US avoid a recession by supporting services spending. Services spending is the main driver of US economic growth. Meanwhile, a looming government shutdown threatens market participants who will be “blind flying,” as important data releases won’t be published unless Democrats and Republicans extend across the aisle for a handshake. 

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