Updated Dot Plot
September 18, 2023
The Fed is widely expected to pause at this week’s meeting. The updated dot plot seems to be the wildcard with a ~30% chance for the median dot to price out another 25bp hike for 2023. This outcome would signal an end to the hiking cycle and should result in some ‘bull steepening’ of the 5/10 yield curve. Unfortunately, we expect current Treasury supply/demand dynamics would mute the impact and keep the 5/10 yield curve inverted at levels below -7bp. An unexpected break above -7bp should be considered a bullish development for equities. Away from the dot plot, we expect the Fed to remain ‘data dependent’ until the data breaks in one direction or the other. The Fed is looking for a break in the inflation data with three consecutive down YoY headline CPI reports triggering an explicit end to the hiking cycle. Core CPI is expected to trend gently lower in the months ahead, but base effects and elevated energy prices should make headline CPI a headwind for equities until late Q1’24.
A government shutdown shouldn’t be conflated with the debt ceiling and the potential for sovereign debt default. A government shutdown doesn’t actually shutdown all government agencies. We can assume the Departments of Defense, Health and Human Services, Homeland Security, State and other essential agencies remain open for business. We can also assume that the Social Security Administration will continue to make payments. Past shutdowns have been little more than a paid vacation for some government employees and the economic impact has been less-than-catastrophic with the 5-week shutdown in 2018-19 (longest in recent history) reducing real GDP by less than ~0.1%.
This Friday brings flash manufacturing PMI data from the US and Europe. Manufacturing PMI in both geographies has been below 50 all year, indicating contraction. We doubt that US manufacturing PMI can flip into expansion territory this month given signs of deteriorating capex and nascent UAW strike that could weigh on sentiment. Services PMI have been a different story, staying above 50 since February but declining from a May high of 54.9 to 50.5 in August. A slump into contraction territory this Friday could stir recession concerns.