Weekly global economic update

Week of November 18, 2024

• Investors react to changing expectations
• US inflation rebounds slightly
• US household debt increases, but remains modest
• China’s economic data offers a mixed picture
• Eurozone industrial output continues to decline

Investors react to changing expectations

• Expectations about inflation in the United States are influencing bond yields and currency values. Those expectations are based, in part, on expectations regarding US policy. Since mid-September, the five-year breakeven rate (a measure of bond investor expectations of average inflation over the next five years) has increased by roughly 50 basis points. There was a particularly sharp increase in the breakeven rate on the day after the US election. A combination of tax cuts and deregulation are expected to boost aggregate demand, potentially leading to faster economic growth and higher inflation. In addition, potential tariffs are expected to boost inflation by increasing import prices. Consequently, bond yields have risen, thereby leading to an appreciation of the US dollar against other currencies.

The appreciation of the dollar, or depreciation of other currencies, will mean inflationary pressure in those countries that experience depreciation. On the other hand, a cheaper currency will boost export competitiveness for those countries. Conversely, a higher-valued dollar will suppress inflation in the United States while reducing export competitiveness. The higher-valued dollar could help to offset the inflationary impact of tariffs. Also, tariffs might compel foreign companies that export to the United States to boost investment in the United States. This would especially apply to automotive companies based in Japan and Germany.

Meanwhile, some analysts believe that the expectation for tariffs is overblown. Their view is that the threat of tariffs will be used to bring trading partners to the negotiating table. The goal would be to exact trading concessions from partners in exchange for forbearance on tariffs. This strategy was applied in 2019 when the United States agreed to avoid new tariffs in exchange for China pledging to boost imports of certain products from the United States.

As for China, the rise in the value of the US dollar will likely put downward pressure on the renminbi. Yet China has a managed exchange rate wherein authorities set a range in which the renminbi can move against the dollar, with that range being adjusted periodically. When there is pressure on the currency to move outside the range, the central bank steps in and purchases or sells dollars accordingly. Thus, when there is downward pressure on the renminbi, the central bank must sell dollars, effectively reducing China’s money supply. When the US dollar is rising, China’s central bank must decide to either allow the renminbi to fall in value or to tighten monetary policy.

Moreover, historically there has been an outflow of capital from China when investors expect depreciation. Such outflows (which entail circumventing China’s capital controls) put further downward pressure on the currency, creating difficult choices for the central bank. On the other hand, if tariffs are imposed on Chinese exports to the United States, a depreciation of the Chinese currency would help to offset the impact of tariffs on the competitiveness of Chinese exports. Indeed, this is what happened in 2018, the last time the United States introduced significant tariffs on imports from China.

Meanwhile, a rising value of the US dollar could create challenges for emerging countries other than China. Declining currencies would mean more inflationary pressure, thereby possibly leading to tighter monetary policies. Also, if US tariffs are imposed on imports from non-China emerging countries, this too would put downward pressure on currencies. For those emerging nations with fixed exchange rates, central banks will either be forced to allow a devaluation, or they will have to intervene to support their currencies, thereby tightening monetary policy. On the positive side, currency depreciation could boost the competitiveness of emerging market exports. 

Regarding the rise in bond yields, this reflects expectations of higher inflation as well as expectations that the Federal Reserve will cut interest rates more slowly than previously anticipated. Indeed, Fed Chair Powell said that he is in no hurry to cut interest rates. He said that “the economy is not sending any signals that we need to be in a hurry to lower rates. The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully.” He did not comment on the potential impact of the policies of the incoming administration. Investors reacted strongly to his comments. The futures market’s implied probability that the Fed will not cut rates in December is now 42%, up from 28% a day earlier and 14% a month ago. Still, investors see a 58% probability of a 25-basis-point cut in December.  

US inflation rebounds slightly

• Inflation in the United States accelerated slightly in October. However, one month does not make a trend. Last week’s report is not necessarily an indication that the long deceleration in inflation is ending. It might simply be a blip while the downturn trend continues. If there were to be a rebound in inflation due to policy changes, it would likely not show up for quite some time. Let’s look at the details of the latest consumer price index (CPI) data.

In October, the CPI was up 2.6% from a year earlier, up from 2.4% in September and the highest rate of inflation since July. Prices were up 0.2% from the previous month, the same rate of growth as in each of the past four months. When volatile food and energy prices are excluded, core prices were up 3.3% from a year earlier, the same as in September. Core prices were up 0.3% from the previous month, the same as in each of the past three months. As such, underlying inflation appears to have settled at a low level, but not as low as the Fed would prefer.

Overall, this is a very favorable report, indicating that inflation is close to the Fed’s 2% target. However, core inflation remains a bit too high. The persistence of core inflation will likely play a role in tempering the Fed’s willingness to cut interest rates further.  

Here are some details from the CPI report. Energy prices fell 4.9% in October versus a year earlier, yet electricity prices were up 4.5%. Food eaten at home was up only 2.1% while food eaten away from home was up 3.8%, reflecting that labor-intensive services such as restaurants still face rising labor costs. Meanwhile, prices of durable goods fell 2.5% while prices of non-durable goods fell 0.5%. Yet prices of services were up 4.7%. The persistence of service inflation, which partly reflects rising wages in a tight labor market, is a concern for the Federal Reserve. On the other hand, the Fed is likely hopeful that increases in labor productivity will continue, thereby dampening the inflationary impact of rising wages. 

Financial markets barely reacted to the inflation report. The slight rebound in inflation was not seen as indicative of anything important. Asset prices have already adjusted to the results of the election. Now investors are awaiting more details on who will staff the new US administration and what specific policy proposals will be offered. 

Still, we have seen the value of US dollar rise to a six-month high. This reflects an expectation of significant tariffs to be introduced by the United States. The rise in the dollar is due to expectations of higher borrowing costs following higher inflation from tariffs. Yet there is another reason why expectations of tariffs boost the dollar. The US trade (current account) balance is due to a gap between saving and investment. The US invests more than it saves. It makes up the difference by borrowing from foreigners. Hence, the trade deficit. 

Yet tariffs can undermine imports, reducing the trade deficit. This is then offset by a rising currency, which boosts imports. The net trade balance is not determined by tariffs. Instead, it is determined by saving and investment behavior. Consequently, tariffs do not cut the trade deficit as they are offset by currency movements. If the goal is to reduce the trade deficit, the best thing to do is either engineer a recession that reduces investment or cut the budget deficit to increase saving.

US household debt increases, but remains modest

• Household debt in the United States continued to grow in the third quarter of 2024. Yet, income grew faster. Consequently, the debt-to-income ratio continued to decline and remains at an historically low level. In fact, excluding the brief post-pandemic period, the debt-to-income ratio is now the lowest it has been since early in this century. As such, household balance sheets appear to be in good shape. Still, the delinquency rate on credit card has risen sharply and is approaching the level last seen during the global financial crisis. This ratio rose from 5.8% in the third quarter of 2023 to 7.1% in the third quarter of 2024. 

On the other hand, the delinquency rates on other forms of household debt remain very low. For example, the delinquency rate on mortgages was only 1.1% in the third quarter. The figures were 0.43% for home equity loans, 2.9% for automotive loans, and 0.77% for student loans. For all forms of household debt, the delinquency rate rose from 1.28% in the third quarter of 2023 to 1.68% in the third quarter of 2024. 

This looks like a very favorable situation that implies little risk to the financial services sector. However, the sharp rise in delinquencies on credit card debt might have an impact on spending in the months to come. This is likely to deter spending on big ticket items or large-scale purchases. As such, my own expectation is that the rate of growth of consumer spending will ease in the coming year, thereby causing real GDP growth to decelerate modestly.  

China’s economic data offers a mixed picture

• The Chinese government recently released economic data for October. It was a mixed bag. On the one hand, retail sales rebounded nicely. Investment in manufacturing grew strongly. On the other hand, property investment continued to fall sharply while industrial production grew more slowly than expected. Let’s look at the details.

In October, retail sales in China were up 4.8% from a year earlier, the strongest growth since February. Some categories saw very strong growth. This included sports and entertainment (up 26.7%), household appliances (up 39.2%), and cosmetics (up 40.1%). It is possible that some of the stimulus measures implemented by the government either boosted spending or boosted confidence on the part of households. 

On the other hand, home prices continued to decline as the troubled property sector continued to implode. In China’s 70 largest cities, prices of newly built homes were down 5.9% from a year earlier, the sharpest decline since 2015. Prices fell even more sharply in Guangzhou (down 10.4%) and Shenzhen (down 8.1%). However, prices were up 5% in Shanghai. The decline in prices implies a loss of wealth for households. That can encourage households to save more and spend less.

Meanwhile, industrial production was up 5.3% in October versus a year earlier, roughly in line with the experience of the last six months. Manufacturing output was up 5.4%. In addition, fixed asset investment for the first 10 months of 2024 was up a modest 3.4% from a year earlier. Investment in manufacturing was up 9.3% while investment in property was down 10.3%. 

As reported previously, exports grew strongly in October. Yet given the likelihood of significant US tariffs on China, and the deteriorating relationship between China and the European Union (EU), there could be challenges for China to continue to grow based on exports. The more modest growth of domestic demand is a concern. The recent fiscal policy moves by the government are meant to boost domestic demand. It is too early to say if this will be successful. 

Eurozone industrial output continues to decline

• For the past two years, industrial production in the Eurozone has been on a relatively steady downward path. That remained true in October, according to the latest data from the EU. Industrial production in the Eurozone had peaked in February 2023 and, since then, has fallen 8.3%. In October, industrial production was down 2% from the previous month and down 2.8% from a year earlier. On a monthly basis, output has fallen in four of the last six months. 

From a month ago, output fell 1.5% in the energy sector and 3.8% for production of capital goods (not boding well for future investment spending). Output of intermediate goods was unchanged. On the other hand, output of durable consumer goods was up 0.5% while output of non-durable consumer goods was up 1.6%. 

By country, industrial production fell 2.7% in Germany from the previous month, fell 0.9 in France, fell 0.4% in Italy, increased 0.9% in Spain, fell 2.9% in the Netherlands, and increased 0.4% in Belgium.

The weakness of the industrial side of the Eurozone economy reflects the impact of high energy costs, high interest rates, weak external demand (especially in China), and tight fiscal policies in many European countries. On the other hand, the evident rebound in output of consumer goods suggests that the consumer side of the economy is improving. That could be due to rising real wages, continued job growth, and declining interest rates.

To the extent that economic growth is taking place in Europe, it has more to do with services than with the goods side of the economy. Indeed, it is in services where inflation persists while prices of goods are stagnant.

Week of November 11, 2024

• Does the US budget deficit matter?
• Federal Reserve continues to ease monetary policy
• US labor productivity continues to grow strongly
• Bank of England cuts rates once again

Does the US budget deficit matter?

• Interestingly, during the US election campaign that ended recently, almost nothing was said by either candidate about America’s burgeoning public sector debt. Rather, much was said about immigration, inflation, abortion, and trade—all important issues. But how the government finances (or fails to finance) its expenditures, which is a hugely important issue, did not attract much attention. Meanwhile, the issue has been of concern to business leaders, judging by the questions I’ve received when presenting the economic outlook. Is this concern warranted? 

First, some facts. In the fiscal year that just ended, the Federal government’s budget deficit (expenditures minus revenues) is estimated by the Congressional Budget Office (CBO) to have been 6.7% of GDP. This is an unusually high number given that the economy is running close to full capacity, with an historically low unemployment rate. The only times in our history that the deficit/GDP ratio was higher was either during deep recession or during and immediately after World War Two. Moreover, given the tax and spending plans of both candidates for president, it is likely that the deficit will remain relatively high in the years to come, if not higher.

Meanwhile, the level of debt is also historically high. There are three ways to measure the debt. First, there is the total debt, regardless of who holds that debt. By that measure, the debt/GDP ratio by end of fiscal year 2022 was 123.4%. This was down from an historic peak of 127.7% in FY2020, at the peak of the pandemic. During World War Two, it never reached this level. 

The second measurement is debt held by the public. This excludes debt held by government accounts such as the Social Security Trust Fund. By this measure, the debt/GDP ratio was 97% in FY2022, and likely 99% by the end of FY2024. In FY2020, this ratio was 99.7%. Prior to that, it had only been higher in FY1945 and 1946 at 103.9% and 106.1%, respectively. Moreover, under either candidate, it will likely go significantly higher in the years to come. 

Finally, the third, and likely most important, measurement is debt held by the public excluding that held by the Federal Reserve. Fed holdings increased significantly in 2010 during the global financial crisis and again in 2020 during the pandemic. These increases were part of the policy of quantitative easing in which the Fed purchased government bonds and other securities to boost liquidity. The idea was to avert a decline in the money supply (which happened during the Great Depression) because banks were not lending. This measure is important because it reflects the true impact of government debt on the private sector. By this measure, the debt/GDP ratio was 74.5% in FY2022, down from 78.7% in FY2020. The only time it had been higher than this was in the period 1944 through 1948, when it peaked at 95.6% in 1946. Again, under either candidate, this ratio is expected to rise in the years to come. 

Thus, the deficit and the level of debt are both historically high, although not yet catastrophically so. Should we be concerned? Yes and no. Normally, a large amount of government borrowing is worrisome because, as the government competes with private investors for scarce funds, it drives up borrowing costs, thereby stifling investment and economic growth. That has not been the case in recent years. In addition, if investors are wont to purchase government debt, then central banks could monetize the debt, thereby fueling ruinous inflation. That has not been the case either. 

Also, the existence of a large volume of debt, combined with expectations that it will grow, might spook investors who are fearful of default or inflationary monetization. This could lead to a financial crisis. So far this has not happened. Moreover, Japan offers an interesting case in that its debt/GDP ratio is far higher than that of the United States. Yet its borrowing costs and inflation have been much lower. This suggests that a developed economy can manage a large amount of debt without onerous consequences. 

On the other hand, there must be a limit to how far any government can go. After all, we know from the experience of some countries that excessive debt and government borrowing does lead to weak economic growth and/or very high inflation. Consider the case of Germany during the 1920s or, more recently, Greece during the 2010s. Plus, countries such as Venezuela, Argentina, and Zimbabwe offer extremely worrisome examples. 

Still, the United States is different from these countries. The United States issues the world’s dominant currency. As such, it has what has been described as an “exorbitant privilege.” Not only is its external debt in its own currency. Global investors crave US dollars, especially during uncertain times. The market for US government debt is huge, liquid, transparent, and reliable. Thus, the United States can likely engage in a more expansive, fiscal policy than other countries without noticeable consequences. 

Nevertheless, this cannot necessarily go on forever. Absent a shift in policy, there will likely come a time when the United States will pay a price for its largesse. We just don’t know when that time will be. It could be a long time from now. After all, I’m old enough to remember stark warnings about US fiscal policy in the 1980s when deficits were relatively high following big tax cuts and increases in defense spending. Pundits warned that a crisis was imminent. It never came. 

So, what can be done? The ugly trajectory of future deficits stems in large part from demographics. That is, an aging population means more spending on entitlements for the elderly, such as Social Security and Medicare. A slow-growing working-age population means inadequate growth of government revenue, absent tax increases, to fund these programs. To address this issue, there are several things that could be done. For example, the retirement age could be increased, taxes could rise, benefits could be cut, other types of government spending could be cut, or immigration could be boosted (thereby raising the ratio of workers to retirees). None of these would be politically easy, but a combination of them would likely solve the problem.

Also, a big chunk of Federal government spending goes to health care (such as Medicare, Medicaid, and veteran’s benefits). The hope is that new technologies such as gen AI will likely boost the productivity of health services, thereby lowering costs. If that were to happen, it would likely have a big impact on government deficits. This remains a big unknown.

In any event, government leaders will not likely be willing to take the risk of addressing this long-term problem until it becomes a short-term problem, fueled by investor concern. Recall that, in the 1990s, political consultant James Carville said: “I used to think that if there was reincarnation, I wanted to come back as the president or the Pope or as a 400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.” Once the bond market intimidates politicians about the debt situation, then action will become likely.  

Federal Reserve continues to ease monetary policy

• After having initiated the easing of monetary policy by implementing a 50-basis-point rate cut in September, the US Federal Reserve followed up recently with an expected 25-basis-point cut in the Federal Funds rate. This was widely expected. The target Federal Funds rate will now be in a range of 4.5% to 4.75%. The decision was unanimous.

The Fed action comes on the heels of the US election. Following the election there was a sharp rise in US equity prices on expectations of fiscal stimulus from a potential tax cut. There was also a rise in bond yields on expectations of higher inflation, the latter due to anticipated tax cuts and tariffs. As such, investors have revised their expectations for Fed policy going forward, anticipating slower monetary easing than previously. For example, futures markets are now pricing in a 67.8% probability that there will be another 25-basis-point rate hike in December, down from 78.3% a month ago. In addition, investors see a 32.2% probability that the rate will not be cut in December, up from 14.3% a month ago. Interestingly, the Fed did not provide any forward guidance about the direction of future policy, only saying that it will be data driven. 

The Fed action was based on a view that inflation is largely under control, although the Fed said that inflation remains “elevated,” mainly due to persistent inflation in services. Moreover, although the economy is strong and the labor market relatively tight, the Fed is concerned that a continuation of tight monetary policy could damage the economy as the lagged impact of high interest rates takes their toll. Plus, the Fed is likely pleased that labor productivity continues to grow rapidly, thereby offsetting the inflationary impact of a tight labor market. 

The Fed judges current interest rates to be reflective of a tight monetary policy. The goal is to bring rates down to a point where monetary policy is neutral rather than tight. However, Fed Chair Powell said that, although the goal is to bring monetary policy toward neutrality, “nothing in the economic data suggests that the committee has any need to be in a hurry to get there. We are seeing strong economic activity. We are seeing ongoing strength in the labor market.”

When asked how the policies of the new administration might influence monetary policy, Fed Chair Powell refused to comment, saying that it is too early to judge the specifics of any new policy. On the other hand, he said that the Fed would take into account any future changes in government borrowing costs that might stem from changes in fiscal policy. In addition, Powell said that he intends to retain his position until the end of his term as Chairman in May 2026. At that time, a new Chairman could be appointed. 

• The Federal Reserve has a dual mandate from the US Congress: to minimize inflation and maximize employment. Yet there is implicitly a third mandate, which is to maintain financial stability. As such, the Fed pays close attention to stress in financial markets and the factors that create stress. Currently, one area of concern is the market for commercial property mortgages, principally those backing office property. 

Banks often allow troubled borrowers to extend mortgages rather than allowing them to default. Yet it is reported that the number of borrowers at risk of a “second default” has risen sharply, reaching the highest level in a decade. The volume of mortgages that are delinquent has risen sharply since late 2022. The rise in delinquencies followed the tightening of monetary policy by the Federal Reserve. The hope now is that, as interest rates come down, the number of mortgage holders facing trouble will likely decline. However, if the easing of monetary policy slows, it could spell trouble for some borrowers.

Clearly, the underlying problem has been the adoption of hybrid work practices by office workers. The share of workers spending part of each week at home is much higher than prior to the pandemic. This means reduced demand for office property and, in some cases, reduced valuations of office property. Meanwhile, the Federal Reserve Bank of New York reported that the practice of extending mortgages for troubled borrowers could cause a “buildup of financial fragility.” That is because this practice can mask the underlying problem, leading to a misallocation of credit.  

US labor productivity continues to grow strongly

• In the United States, productivity has been rising strongly for the past two years, thereby putting downward pressure on inflation while boosting GDP growth. Recently, the US government reported that this continued in the third quarter. Moreover, overall growth of labor productivity was faster than growth of productivity in the manufacturing sector. This is interesting as it is the opposite of what has happened for many years. It implies that productivity in the services sector is growing strongly, something we have not seen before. This suggests that service-oriented businesses are taking advantage of labor-saving and labor-augmenting technologies to boost output without boosting employment commensurately. This is necessary at a time when there is a shortage of labor. Let’s look at the details.

In the third quarter of 2024, labor productivity (output per hour worked) in the non-farm business sector of the United States was up at an annualized rate of 2.2% from the previous quarter and up 2% from a year earlier. In the manufacturing sector, productivity was up at an annualized rate of 1% from the previous quarter and up 0.7% from a year earlier. By inference, service sector productivity grew especially strongly. If that continues, it can be a game changer given the vast size of the services sector.

The increase in overall productivity took place because output grew rapidly (up at a rate of 3.5% from the previous quarter) while hours worked grew more modestly, up 1.2% from the previous quarter. Meanwhile, compensation was up at an annualized rate of 4.2%. As a result, unit labor cost (ULC, or the labor cost of producing an additional unit of output) was up at an annualized rate of 1.9% in the third quarter versus the previous quarter. ULC is an important measure that reflects the impact of both productivity and wages. If ULC grows slowly, as was true in the third quarter, it has a dampening effect on inflation. That is because productivity growth is partly offsetting the inflationary impact of rising wages. From the perspective of the Federal Reserve, this is good news.

The big question now is whether this surge in productivity will continue in the coming year and beyond. The Federal Reserve has indicated that continued strong productivity growth would provide room for an easier monetary policy than otherwise. Notably, the United States appears to be alone among major industrial countries in experiencing strong productivity growth. This has been a source of concern in many countries, with plenty of debate about how to boost productivity growth.  

Bank of England cuts rates once again

• The Bank of England (BOE) implemented the second interest rate cut in this cycle. It cut its benchmark interest rate by 25 basis points to 4.75%. The decision by the committee was eight to one. The first rate cut took place in August. The BOE chose not to move rates at the last meeting in September. BOE Governor Bailey said that “we need to make sure inflation stays close to target, so we can’t cut interest rates too quickly or by too much.” 

British inflation has decelerated sharply since peaking two years ago. In September consumer prices were up 1.7% from a year earlier, below the BOE’s target of 2%. However, that partly reflected a sharp decline in energy prices. Once energy prices stabilize, the BOE expects inflation to rebound slightly in the months to come. Bailey said that he expects the BOE to cut rates gradually in the months to come, provided that the economy evolves as expected.

Meanwhile, the BOE is likely evaluating the impact of the British government’s latest budget plan. Central banks in the United Kingdom, Eurozone, Canada, Japan, and the United States conduct monetary policy independently. However, their decisions are often taken with an eye of government fiscal policy, which can affect such things as borrowing costs, economic growth, and inflation.

Week of November 4, 2024

• US economic performance remains stellar
• US jobs market faces temporary constraints
• Eurozone economy picks up speed
• Eurozone inflation continues to ease
• Germany resists EU tariffs on Chinese EVs
• Mexico increasingly central to the US-China conflict

US economic performance remains stellar

• In the third quarter, the US economy continued to exhibit considerable strength, and the GDP report incorporated evidence of declining inflation. There are a few negative signs, but not sufficient to drive a significant slowdown.

The US government reported that, in the third quarter, real GDP grew at an annualized rate of 2.8% from the previous quarter. This was a bit slower than the 3% growth in the second quarter, but certainly far faster than the long-term ability of the economy to grow. 

Notably, real consumer spending grew at a stellar rate of 3.7%. This included an increase in spending on durable goods of 8.1%, nondurable up 4.9%, and services up 2.6%. Meanwhile, business investment remained robust. Nonresidential fixed asset investment grew at a rate of 3.3%. This included a 4% decline in investment in structures. However, this was more than offset by an 11.1% increase in investment in equipment but only a 0.6% increase in intellectual property. On the other hand, residential investment fell at a rate of 5.1%, the second consecutive quarterly decline.

Also, exports of goods and services grew rapidly at 8.9%, led by goods more than services. Imports were up at a rate of 11.2%, evidence of strong domestic demand. Finally, government purchases were up 5%, led by defense spending at 14.9%. Overall, the report indicated underlying strength. 

Going forward, there are a couple of reasons to expect real GDP growth to decelerate modestly. First, the delinquency rate on credit card debt is now relatively high. This will likely restrain the ability of consumers to continue making purchases of durable goods. Second, the GDP report indicated that real disposable personal income grew slower than real consumer spending. Consequently, the personal savings rate fell. This cannot go on forever. Third, the restrictiveness of monetary policy has resulted in a sharp increase in business bankruptcies. Although monetary policy is now easing, it remains tight. Bankruptcies can hurt investment and employment. Also, growing government debt, especially if the next US president implements a fiscal expansion, if perceived by investors as unsustainable, could lead to higher borrowing costs, thereby hurting investment. Finally, implementation of more trade restrictions would reduce consumer purchasing power and might ignite higher inflation, leading to tighter monetary policy than otherwise.   

Lastly, the GDP report included quarterly data on the Federal Reserve’s favorite measure of inflation: the personal consumption expenditure deflator, or PCE-deflator. In the third quarter, it was up from the previous quarter at an annualized rate of only 1.5%. This included declining prices of goods offset by only a 3% increase in the price of services. Moreover, the core PCE-deflator (excluding energy and food) was up at a rate of only 2.2%. 

• Following on its strong GDP report for the third quarter, the US government released data on personal income and consumer spending for September. It is the most recent picture we have of the consumer economy. Moreover, it includes data on the Federal Reserve’s favorite measure of inflation. Let’s look at the details.

In September, real (inflation-adjusted) disposable income (after taxes) was up only 0.1% from the previous month. Yet real consumer spending was up 0.4%. This means that households saved less in September than in August. That is, the personal savings rate fell from 4.8% of income in August to 4.6% in September. The savings rate has been steadily falling since a recent peak of 5.4% in January. It is not clear how long this trend will continue. The September rate is the lowest since last December. However, both real disposable income and real consumer spending were up 3.1% in September versus a year earlier. Thus, in the longer term, income and spending have moved together at a healthy pace.

Regarding consumer spending, real spending on durable goods was up 0.4% in September from the previous month, nondurables up 0.8%, and services up 0.2%.

Finally, the government released data on the Fed’s favorite measure of inflation. The PCE-deflator was up 2.1% in September versus a year earlier, the lowest level of headline inflation since February 2021. There was a decline in the prices of goods that was more than offset by a rise in the prices of services. Specifically, the price of durable goods was down 1.9% from a year earlier while the price of nondurables was down 0.8%. Meanwhile, the price of services was up 3.7%, the same as in July but down substantially from the recent past.

One reason for the low level of headline inflation was a sharp decline in energy prices in September. When volatile food and energy prices are excluded, the core PCE-deflator was up 2.7% from a year earlier, roughly unchanged over the past five months. Thus, underlying inflation has stabilized at a level slightly higher than the Fed’s 2% target. Still, the target is not meant to be a ceiling, but rather an average. As such, inflation appears to be under control. 

This latest report offers further support for the soft-landing scenario. Consumer spending remains healthy, although income growth has decelerated. Meanwhile underlying inflation is close to the Fed’s target. Consequently, it is reasonable to expect a continued easing of monetary policy, but at a moderate pace. It is also reasonable to expect some deceleration in economic activity. However, a recession is very unlikely.

US jobs market faces temporary constraints

• The October employment report from the US government indicated almost no job growth. Yet investors were not disturbed as there were special circumstances that led to the weak job growth. Specifically, there were two hurricanes in the Southeast region of the United States. In addition, there was a major labor strike at Boeing. The result was slow job growth of only 12,000. Yet this was not unexpected. Just a few weeks ago, Fed Governor Christopher Waller said that the hurricanes and strike “may reduce employment growth by more than 100,000 this month.” Evidently that is what happened. Moreover, investors failed to react, with bond yields and equity prices not moving significantly today. Let’s look at the details.

The US government produces two reports on the job market: one based on a survey of establishments; the other based on a survey of households. The establishment survey found that only 12,000 new jobs were created in October. More importantly, job growth in the previous two months was revised downwardly. Regarding the October numbers, there was a decline in manufacturing employment of 47,000, largely due to the strike at Boeing and its spillover effect on suppliers. In addition, employment fell modestly at retailing, leisure and hospitality, and transportation and warehousing. These declines were likely related to the hurricanes in the Southeast. Employment fell 47,000 in the professional services industry, mainly due to a drop in hiring at temporary help services, also related to the hurricane. Meanwhile, health care employment was up 52,300 while government employment increased by 40,000. 

The establishment survey also found that average hourly earnings were up 4% in October versus a year earlier, a jump from the previous month and the biggest increase since July. The acceleration in wages was likely due to the disruption from the hurricane, which reduced employment in low wage professions such as retailing and leisure and hospitality. The loss of these jobs boosted the average wage of existing workers. Even at 4%, wage growth is not a big contributor to inflation, especially given that productivity has been rising, which offsets the impact on prices from rising wages.

Also, the separate survey of households, which includes data on self-employment, found a sharp decline in the number of people participating in the labor force. In addition, employment declined commensurately, thereby allowing the unemployment rate to remain steady at 4.1%. This implies stability of the job market. 

It will take at least another monthly jobs report or more before we can make reasonable inferences about the state of the job market. 

• In the United States, the job openings rate continued to decline in September. This is the share of available jobs that are unfilled. It is a measure of the tightness or looseness of the job market. During the pandemic, the job openings rate soared as demand for labor remained robust while the supply of labor fell due to declining participation and immigration. In the past two years, the rate of participation by prime working-age people (25–54) has increased to the highest rate in a quarter century. Plus, immigration has risen. The result has been a sharp rise in the supply of labor, thereby causing the job openings rate to fall from a peak of 7.4% in March 2022 to 4.5% in September 2024. This is the lowest level since December 2020.

Notably, the current rate of 4.5% is relatively high compared to the prepandemic period. Prior to the pandemic, the highest job openings rate on record was 4.8%. Thus, one can reasonably state that the job market remains relatively tight. That, in turn, is consistent with the strong job growth seen in September. 

By industry, the highest job openings rate was in professional services (our industry), at 6.2%. Other high rates were found in hotels and restaurants as well as health care. Low rates were found in wholesale trade, retail trade, and manufacturing.

Eurozone economy picks up speed

• GDP growth in the Eurozone picked up speed in the third quarter. Real GDP was up 0.4% from the previous quarter, the fastest growth since the third quarter of 2022. To compare it to US growth, this was an annualized rate of 1.7% while US growth was 2.8%. The rebound is most welcome after a long period of sub-par growth. Now, with the European Central Bank (ECB) loosening monetary policy, there is hope that growth in 2025 will be significantly better than in 2024. 

By country, quarterly real GDP growth in the third quarter was 0.2% in Germany, 0.4% in France, 0% in Italy, and a stunning 0.8% in Spain. The latter is the fastest-growing large economy in Europe. Meanwhile, the slow growth in Germany remains a concern given Germany’s role as an engine of growth for Europe. Germany evidently has longer-term issues, especially given that real GDP is no higher than just prior to the pandemic. Finally, France’s strong growth was likely attributable to the impact of the Olympic Games during the summer.  

Eurozone inflation continues to ease

• Inflation in the Eurozone rebounded slightly in October but remained quite low. The consumer price index was up 2% in October versus a year earlier. While up slightly from the surprisingly low 1.7% inflation in September, it otherwise was the lowest level since June 2021. October prices were up 0.3% from the previous month. For the ECB, the rise to 2% should not be concerning. After all, the ECB’s target is 2%. It has evidently been achieved. 

Meanwhile, energy prices were down sharply. Thus, when volatile food and energy prices are excluded, core prices were up 2.7% in October versus a year earlier. Core prices were up only 0.2% from the previous month. In addition, while the prices of non-energy goods were up only 0.5%, prices of services were up 3.9% from a year earlier, the same as in September and not down much over the past five months. 

The persistence of service inflation, likely related to rising wages in a tight labor market, has been a source of concern for the ECB. Moreover, the absence of labor productivity growth in Europe has meant that wage gains quickly turn into price increases. Still, the ECB has begun to ease monetary policy, likely concerned that persistent tight monetary policy will weaken the economy. On the other hand, the relatively strong growth of GDP in the third quarter means that the Eurozone has achieved low inflation while the economy has started to rebound.

• One of the factors that held back Eurozone growth in recent years was reticence on the part of consumers. Despite having accumulated a large pool of excess savings during the pandemic, households have been very cautious. The European Union (EU) reports that, in the second quarter, real disposable household income per capita increased 0.4% from the previous quarter. Yet real consumer spending per capita increased only 0.1%. As a result, the savings rate increased from 15.3% in the first quarter to 15.6% in the second quarter. The savings rate increased in Germany, France, and Italy but fell in Spain. If, going forward, European households have greater confidence in the economy, they might start to boost the growth of spending—especially as interest rates come down.  

Germany resists EU tariffs on Chinese EVs

• The EU is implementing severe tariffs on imported electric vehicles (EVs) from China. This is an effort to protect Europe’s burgeoning EV industry, especially given the very low prices charged by Chinese producers. The EU says that Chinese producers are subsidized by their government. The Chinese producers say that they have achieved scalar efficiency through massive investment. Consequently, their costs are relatively low.

Meanwhile, Germany’s car makers are not happy. They indicate that the EU tariffs create the risk of a trade war. Moreover, they fear that such a war might be waged against them. Major German car makers are active in the Chinese market and want to retain their access to that market. Yet weak domestic demand in both Germany and China have led to declining earnings. A trade war could make things much worse. 

Mexico increasingly central to the US-China conflict

• Mexico is fast becoming an important factor in the ongoing tension between the United States and China. Mexico is party to the USMCA (US Mexico Canada Agreement), a free trade agreement that is the successor to NAFTA. As such, producing goods in Mexico offers easy access to the vast US market. Meanwhile, the United States has imposed substantial trade restrictions on China and could impose more going forward. Consequently, an increasing number of Chinese companies are setting up shop in Mexico, hoping to gain access to the US market. Moreover, they and other companies are taking advantage of Mexico’s relatively low labor costs and low costs of transporting goods to the United States. 

The Mexican Chinese connection has been growing rapidly. Chinese foreign direct investment (FDI) into Mexico was US$3.77 billion in 2023, double that of the year before. Also, by 2020, 21.2% of Mexican exports to the US had Chinese content, up from just 5% in 2002. To gain free access to the US market, the USMCA requires a minimum level of domestic content for Mexican exports. A Chinese company cannot simply reexport Chinese made goods to the United States through Mexico without facing tariffs.

As global companies reduce exposure to China and shift production to Mexico, there has been a shift in trade patterns. Today, Mexico is the largest exporter to the United States, having superseded China just last year. Going forward, the USMCA must be renegotiated in 2026. The role of Chinese companies in Mexico is likely to be a major issue in these negotiations. This must be of concern to Chinese companies currently investing in Mexico as well as those already active in Mexico. If the renegotiation results in restrictions on US-Mexico trade involving Chinese-made products, there would have to be a major unravelling of existing supply chains.