Top of the Morning: State of the US economy & Fed outlook

Andrew Dubinsky · UBS

Fed likely holds in October, then hikes 25bp in December, with risks skewed to more hikes.

The September hike came with hawkish forecasts that showed a 3.4% core PCE projection. Since then, inflation revisions have lowered the pace of inflation, the jobs report shows no overheating, and influential Fed speakers have signalled less urgency to keep tightening. Andrew expects a hold at the October meeting, with possible dissents from members who want more hikes. He expects at least one more 25bp hike in December, with the base case of one or two more in total. Risks are skewed toward more hikes, including a possible third in March, depending on early-year inflation.

“we're expecting the Fed to remain on hold at the next meeting and then likely resume with at least one more hike in December.”at 5:37

Andrew Dubinsky · UBS

One or two more hikes won't disrupt growth or markets, and market pricing exceeds that path.

Andrew argues that the base case of one or two more hikes should not hurt growth much or be too disruptive for markets. He says this is less tightening than markets are currently pricing, which is by a few hikes more. He expects that pricing could change as the Fed communicates that it is not looking to do much more. The Fed does not look set for an aggressive hiking cycle that would disrupt an expansion that remains on solid footing.

“So it shouldn't be too disruptive for markets. Obviously, that's less in terms of those number of hikes that we're talking about, that's less than the pricing by [a few hikes].”at 6:53

Andrew Dubinsky · UBS

Labor market is on solid footing: slower hiring but sustainable, with stable unemployment and no overheating risk.

September monthly payrolls grew only about 29,000, roughly 60,000 below consensus, with a drag from government employment. The three-month trend is around 50,000, within break-even job growth, which is enough to keep unemployment stable. Unemployment edged up only slightly, and participation rebounded after a weak labor-supply trend. The 'silver lining' is that growth is slower and more sustainable, so the report raises no major concerns about the expansion.

“still growing at a solid pace when we look at the three month trends, smoothing through the volatility of the month to month data.”at 1:09

Andrew Dubinsky · UBS

Slowing wage growth means less income support for consumer spending into Q4 and the year ahead.

Wage growth kept slowing and is now around 3%. Andrew reads this as evidence that labor markets are not creating inflation pressure, and also that households have less income support. As a result, he expects spending to lose income support going into the fourth quarter and the year ahead. He does not expect this to push the economy into recession, but he sees the income backdrop as weaker than the GDP momentum would imply.

“the wage growth continued to slow down, so it's down to around 3%... it's just another sign that we don't have inflation pressures from the labor market and we probably have less income support as we look at spending as we get to the fourth quarter and the year ahead.”at 2:11

Andrew Dubinsky · UBS

Q3 GDP tracks above 3% but should settle near 2%, supported by AI capex and past equity gains.

Third-quarter GDP is tracking above 3%, but Andrew thinks growth is more likely to move back toward a 2% pace. The main support is a consistent tailwind from AI capital expenditure, with some remaining support from past equity market gains. Income growth looks too weak to sustain 3% growth, so he sees the expansion as solid but moderating.

“Right now in the third quarter tracking over 3%, more likely that it moves back to a more like a 2% type number with the consistent tailwind of AI CapEx.”at 3:14

Andrew Dubinsky · UBS

Core inflation near 3% should keep improving as Iran-war energy price effects drop out next year.

Core PCE inflation is still elevated at about 3% year over year, slightly softer after revisions. Andrew expects it to keep improving, especially in the first quarter of next year. By then, the energy price effects that followed the start of the Iran war will drop out of the year-over-year comparison. Headline inflation may look worse month to month in the near term because of energy, while core stays not far from target.

“inflation looks like it'll continue to improve particularly as we get to the first quarter of next year when we lap some of those energy effects that occurred around the start of the Iran war conflict.”at 4:01