• 2020 has been a very difficult year on many fronts, and the economic outlook for Q4 is less certain with Congress unable to agree on additional fiscal aid
  • Despite the uncertainty, the economic data trend, as a whole, continues to exceed expectations, although the September jobs report surprised to the downside
  • The September FOMC statement included a change to the Fed’s forward guidance to account for the recent policy framework shift to average inflation targeting, and the updated Summary of Economic Projections shows no change in the fed funds rate through 2023

With the third quarter in the rear-view mirror, we can only hope that the remaining three months of 2020 will bring a more positive ending to what has been a very difficult year. However, the current political theater leading up to the November election does not offer much encouragement, and several sectors of the U.S. economy continue to suffer from Covid-driven social distancing measures. While the Fed is taking extraordinary measures to support the economy within its defined limitations, Congress has remained at a stalemate regarding additional fiscal aid amid the ongoing pandemic. There have been some positive developments on that front in the last week, but the probability of getting a deal done before year-end still appears low. However, it’s not all doom and gloom. Despite this negative backdrop, the economic data have continued to exceed expectations, with the Citi Economic Surprise Index holding significantly above its historical average (see Exhibit 1). Will the lack of additional fiscal aid stymie this positive momentum in Q4? That is the question many economists have been pondering of late.

Continuing the economic data discussion, the housing market continues to perform well on a national basis, including home sales and prices. Core capital goods orders significantly exceeded expectations in August, suggesting business investment is rebounding despite general uncertainty related to Covid and the election. However, the retail sector continues to face significant challenges. To be clear, these challenges did not begin with Covid in the age of Amazon and other digital marketplaces, but the pandemic has clearly expedited the demise of many U.S. retailers. According to the bi-annual bankruptcy report from BDO, 29 retailers have filed for Chapter 11 through August, on pace to eclipse the 2010 record of 49 retail business failures in the wake of the financial crisis.

On the inflation front, the August PCE report showed some signs of life, with the year-over-year core metric rising 20 basis points (bps) to 1.6%. However, we would be careful to presume inflation pressures will be an issue anytime soon. Market inflation expectations, as measured by TIPS breakeven yields, remain stubbornly low even after the Fed’s recent policy framework change to an average inflation targeting approach (more on that below).

The labor market will continue to be a central focus of financial markets, and the September jobs report, while good, revealed some potential areas of concern. The headline unemployment rate fell 50 bps to 7.9%, but the main driver for the decline was less auspicious. Household employment rose by 275,000 in the month, but the official labor force contracted by 695,000, which pushed the labor force participation rate down 30 bps to 61.4%. The latter will likely be a bigger talking point in economic and policy circles in the coming days/weeks. With enhanced Federal unemployment benefits expiring back in July, one would have reasonably expected labor participation to increase at this point. This may increase calls for additional fiscal aid from Congress, but both sides continue to struggle to reach an agreement.  

The Doves Are Here To Stay

The September FOMC official statement included new policy guidance in line with the recent framework changes, including a shift to average inflation targeting. The Committee now expects to keep the fed funds rate unchanged until “inflation has risen to 2% and is on track to moderately exceed 2% for some time.” The FOMC also released its updated Summary of Economic Projections (SEP), which included projections through 2023 for the first time (see Exhibit 2). The median participant forecast for the fed funds rate shows no hikes through the end of 2023. Furthermore, the inflation rate is projected to be at 2% by that time and the unemployment rate at 4%…

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