Fabian Estevez

After November’s inflation came in at an annual rate of 3.1%, in line with expectations and representing a slight deceleration compared to the 3.2% recorded in October, and following the release of employment numbers, which generally indicated a strong labor market (adding +199,000 new jobs with an unemployment rate of 3.7%), the Federal Reserve (FED) made the unanimous and widely anticipated decision to keep the target range for the federal funds rate unchanged at 5.25% – 5.50%, marking the highest level in the last 22 years. This meeting represents the third consecutive occasion in which the FED opted to keep the reference rate unchanged. The statement noted that employment generation has moderated since the beginning of the year, although it remains strong, and the unemployment rate has remained low. Meanwhile, inflation has declined over the past year but remains elevated.

As mentioned in recent meetings, the statement reaffirmed that, in determining the degree of additional monetary policy tightening to eventually bring inflation back to 2%, the Committee will take into account all implemented measures, the lags with which monetary policy impacts economic activity and inflation, and the development of economic and financial factors. Therefore, the Committee will continue to evaluate additional information as it emerges and its implications.

On the other hand, the FED updated its macroeconomic expectations shared in September. In detail, an upward adjustment in the growth forecast for this year to 2.6% from 2.1% was observed. For 2024, the estimate points to an expansion of 1.4%, implying a slight reduction. The new projections for the labor market remain unchanged, with the unemployment rate closing the year at 3.8% and rising to 4.1% in 2024. Another significant point in the statement is the expectation for the federal funds rate to end this year at 5.4% (revised from 5.6%) and potentially end at 4.6% in 2024 (revised from 5.1%). This implies that in 2024, there could be different cutbacks accumulating an adjustment of 80 bps (a scenario less aggressive than market estimates, assuming cutbacks in 2024 totaling 100 bps). This trend of cutbacks would be maintained for the following years, leading to the rate reaching 2.9% in 2026.

During his press conference, Jerome Powell stressed that it is still too early to declare victory. Therefore, it will take some time for inflation to return to the 2% target. However, he expressed satisfaction with the progress observed in controlling inflation. Finally, he pointed out that the baseline scenario no longer implies a new increase in the reference rate, as was envisaged 60 or 90 days ago.

FED macroeconomic perspectives (December vs. September)

Source: Federal Reserve

In recent days, famed investor Charles (Charlie) Munger and right-hand man to Warren Buffett, passed away at the age of 99. Charlie Munger was the vice chairman of Berkshire Hathaway and a lifelong partner of Warren Buffett, who is widely recognized as one of the boldest investors of recent times. Together, Munger and Buffett grew Berkshire from a small textile manufacturer to a massive conglomerate with a market capitalization of approximately ~US$775bn and a broadly healthy financial position.  

Munger’s philosophy was deeply rooted in the concept of “multidisciplinary thinking,” emphasizing the importance of drawing insight from diverse fields of knowledge, including psychology, history and economics. Munger stood out in the investment environment for making decisions under a “fundamentals-based approach,” i.e., evaluating the essential aspects of an entity, such as its revenue sources, earnings potential, balance sheet health and market position, among other aspects. In this context, below we share some of the investment insights that he promoted along with Warren Buffet:

• ” The big money is not in the buying and selling, but in the waiting.” This means, in terms of managing a portfolio, that Munger was not active in day to day buying and selling. Rather, he would strive to identify positions that he considered as safe as possible and hold them, often for several years.
• “Buy wonderful businesses at fair prices.” Munger avoided stocks that other investors might buy simply because they appeared to be a good deal. Instead, he opted for investments in companies with strong fundamentals and reasonable valuations because he believed that eventually the market would recognize their intrinsic value (fundamental value) over the long term. 
• “Great opportunities are rare.” Munger made investment decisions under the philosophy that “life is not showering you with unlimited opportunities.” Therefore, his goal was to rule out as many bad or unsubstantiated investment ideas as possible. Only those ideas that survived strict scrutiny would be considered for implementation. In this sense, he favored the implementation of significant moves at those rare moments when a tremendous opportunity presents itself, after thorough analysis has been performed.
• “Good business are ethical business.” One of Munger’s favorite tenets was that “good business is ethical business,” and, conversely, that “a business model that depends on deception is doomed to failure.” Munger and Buffett built a reputation for closely analyzing the businesses they were considering investing in, looking for companies with excellent growth potential and models they considered fair, equitable and ethical.

Among his many reflections, perhaps one of the most significant was not focused on investments or business, but on a philosophy of life when he said: “The best thing a human being can do is to help another human being know more.”

Annual returns and intra-annual declines of the S&P 500

Note: Despite average intra-annual declines of 14.3%, annual returns were positive in 32 of the 43 years.

Source: JP Morgan

Online shopping during Black Friday increased 7.5% compared to the previous year, reaching a record $9.8bn, according to a report from Adobe Analytics. Adobe compiles its data by analyzing more than one trillion visits across retail websites, 18 total product categories and 100 million unique items. It is worth noting that Black Friday’s momentum carried over from the previous day on Thanksgiving, after online sales totaled US$5.6bn. 

The report detailed that a very strategic consumer was observed in the last year, trying to make the most of seasonal discounts in the face of a tighter budget due to the impacts of inflation and high interest rates. Particularly, US$79 million of sales came from consumers who opted for the flexible payment method, that is, “Buy now, pay later”, which represented an increase of 47% over last year.  However, this payment method between November 1 and November 23 totaled US$5.9bn, an increase of 13.4% over 2022.

On the other hand, it stood out that $5.3 billion of online sales came from mobile shopping, where influencers and social media advertising made consumers feel comfortable spending from their mobile devices. Additionally, Cyber Monday sales are expected to reach up to $12.4 billion, making it the largest online shopping day of the year in the US. Finally, the report revealed that the best-selling categories during Black Friday were electronics such as smartwatches and TVs, as well as toys and games. Meanwhile, home repair tools performed less encouragingly.

In previous days, the National Retail Federation, which groups several retail chains, predicted a possible record consumption during the holidays in November and December, with a growth of 3% to 4% compared to 2022.

Historic holiday sales (US$bn)

Source: National Retail Federation (NFR)

Javier Milei (La Libertad Avanza – LA) won in the run-off by a relatively wide margin and will be the next president of Argentina, as of December 10th, 2023. Milei obtained 55.7% of the valid votes against 44.3% for Sergio Massa (Unión por la Patria – UP), who proposed to work with the president-elect in an orderly transition. 

There are expected to be policy changes, but analysts are aware of the political limitations. The support of Juntos por el Cambio (JxC) legislators is a necessary condition to pass legislative forms, but not sufficient, especially considering that the current administration (UP) will have about half of the seats in the Senate (35 out of 72). 

What is expected from Milei’s administration? 

Exchange rate policy: some analysts expect at least a roughly 80% adjustment of the official FX in December of this year. This move should unlock some pent-up foreign exchange inflows and encourage wheat exporters to quickly ship exports in late December and early January, which could generate inflows of US$ 3 billion. Analysts also expect a new IMF Extended Fund Facility to be negotiated relatively quickly with the IMF, avoiding incurring arrears. 

Fiscal policy: Milei has pledged to close the primary deficit next year through substantial spending cuts, including, the subsidy bill, discretionary transfers to the provinces, and a reduction in state-owned enterprise deficits. Recent tax changes (income tax and VAT) are expected to be reversed, which would help improve the fiscal outlook. Analysts forecast that the primary deficit will end this year close to 3% of GDP, and a roughly balanced primary fiscal account next year, which should help reduce monetary emission.

Monetary policy: Economists expect a hike in interest rates to help prevent a further decline in the currency. They consider dollarization unlikely for now, given the lack of international reserves. There could be an attempt to move to a “dual currency” system in which both ARS and USD are legally accepted means of exchange.

As for Treasury debt service, the likely early and successful renegotiation of the IMF program could allow refinancing of principal maturities, although we do not expect positive net financing. Currently, there are net principal repayments of $1.4 billion and interest payments of $3.5 billion due in 2024. 

As for bondholders, there is debt service of about $4.3 billion next year ($1.5 billion in January and the rest in July).

However, even with these potential near-term catalysts, the challenges are overwhelming. Looking further into the medium term, it would require a significant shift in sentiment to argue that the baseline scenario should be for no restructuring international bonds. In particular, the assumption of a current account deficit in 2024 despite a better harvest will not be enough to convince the market of a continued ability to pay, particularly ahead of international bond payments that set up to US$5.6 billion in 2025. Broadly negative international reserves and the adverse impact of a possible FX adjustment on external debt are the other key issues, in addition to gauging the extent of political capital amid inflation that is expected to rise much higher. The market must be convinced that the imbalances can be corrected without incident.

International Reserves

Source: JPM

The Consumer Price Index (CPI) remained unchanged in October, holding steady since the 0.4% increase recorded in September. This resulted in an annual rate of 3.2%, slightly below expectations of 3.3% and a decrease from the 3.7% reported in the previous month. Conversely, core CPI inflation, excluding volatile categories such as food and energy, increased by 0.2%, down from 0.3% in September. On an annual basis, it reached a rate of 4%, slightly better than the anticipated 4.1% and matching September’s figure. This marks the lowest level for core inflation in two years.

Gasoline prices fell by 5% in the month (-5.3% annually), reversing the 2.1% gain observed in the previous month. Consequently, the all-energy component declined by 2.5% in the month, leading to a 4.5% annual decrease. Meanwhile, pressure persisted in the food category; food at home increased by 0.3% in the month (+3.3% annually), while food away from home advanced by 0.4% in the month (+5.4% annually). On the other hand, the shelter index advanced by 0.3% in the month (+5.5% annually), showing improvement compared to September’s 0.6% increase (+6.7% annually). This category is crucial, representing the largest average U.S. household expenditure and contributing more than 70% to the total increase in the index excluding food and energy.

The trend in inflation continues to show improvement from the 9.1% peak reached in June of last year. Additionally, October non-farm payrolls revealed a significant deceleration, with only 150,000 jobs created, indicating potential signs that employment is beginning to react to the Federal Reserve’s efforts to correct imbalances, which have contributed to inflationary pressures.

In this context, the consensus probability for December suggests no additional increase in the federal funds rate, which is expected to remain in the 5-5.25% range (the highest in 22 years). However, the prevailing narrative of a tightening environment, i.e., “higher interest rates for longer,” could persist, as reiterated by Jerome Powell on multiple occasions, following his commitment to align policy with the 2% inflation target. He emphasized in recent days that he is not yet confident that enough has been done to bring it to that target.

Change (%) in the last twelve months in CPI and Core CPI

Source: U.S. Bureau of Labor Statistics

Target Rate Probabilities for the FED Meeting on December 13, 2023

Source: CME Group

With the arrival of November, traders are starting to talk about the seasonality that stock markets tend to show heading into the final stretch of the year. According to the Stock Trader’s Almanac, a resource for tracking market patterns and trends, the S&P 500 index and the Dow Jones Industrials have historically recorded an average gain of 1.7% in November since 1950. Meanwhile, the technology-focused Nasdaq index has risen by an average of nearly 2% in November since 1971. These statistics make November the strongest month of the year for the S&P 500 and the second-best month for both the Nasdaq and the Dow.

This market strength in November comes on the heels of September, which historically has been the worst month of the year for stocks. Several theories explain this behavior. For example, September’s poor performance is typically attributed to the change of season, as well as the end of the summer vacations. Conversely, it’s believed that increased consumer spending during the year-end holiday’s bolsters market performance in the last two months of the year. This is often referred to as the “Santa Claus rally”. However, there is a driver of equity rallies that is less anecdotal and has more concrete evidence following the adoption of tax loss harvesting strategies by mutual funds prior to October 31st. This could have a major impact on markets, given that U.S. mutual funds manage more than US$20 trillion in assets encompassing stocks and bonds.

It’s essential to remember that historical patterns can offer insights into short-term market movements, but they may not always hold true, as each economic situation is unique. Currently, we face a scenario of geopolitical tensions in the Middle East, the expectation of high long-term interest rates and the possibility of a soft landing for the economy.

Average monthly return on the S&P 500 from January 1950 to April 2023 (%)

Source: Stock Trader’s Almanac – CNBC

Since the last monetary policy meeting in September, when the Committee chose to keep rates unchanged, the data have shown a robust employment performance and economic growth stronger than expected. Additionally, inflation has improved, albeit at a slower pace, remaining above the target. In this context, in a decision widely anticipated by the market, the Fed once again maintained the target range for the reference rate at 5.25% – 5.50%, the highest level in 22 years. The decision was unanimous.

The statement reflected language very similar to that of September, reaffirming that, in determining the degree of additional monetary policy tightening that may be appropriate to eventually bring inflation back to 2%, the Committee will take into account all the measures that have been implemented so far, as well as the lags with which monetary policy impacts economic activity and inflation, along with the development of economic and financial factors. The Committee will continue to evaluate additional information as it emerges and its implications.

On the other hand, the statement reiterated that ‘tighter financial and credit conditions for households and businesses are likely to exert pressure on economic activity, employment, and inflation. The magnitude of these effects remains uncertain.’ This paragraph refers to the recent tightening environment, especially marked by the sharp spike in Treasury bond yields. These tighter conditions could lead to no change in the reference rate at the next meeting in December as well. So far, this rate scenario is the prevailing market expectation.

During his press conference, Jerome Powell emphasized that inflation has improved. However, he stressed the importance of evaluating more data, indicating that there is still a long road ahead. In this regard, the Fed remains steadfast in its commitment to achieving its 2% inflation target. Powell also reiterated that, to reach this target, it may be necessary to accept economic growth below its potential and a slowdown in job creation. Moreover, on other issues, he noted that, so far, he is not confident that financial conditions are sufficiently restrictive, leaving open the possibility of further rate increases if necessary.

Probabilities for the reference rate target for next December 13

Source: CME Group 

Due to the resilient performance observed so far this year, there is a growing perception in the market that the economy may be heading towards what is commonly referred to as a “soft landing.” In broad terms, this concept pertains to the implementation of a restrictive monetary policy by the Federal Reserve (involving high-interest rates and a withdrawal of liquidity) without causing a severe impact on employment generation and avoiding negative GDP growth. In this context, we present some key points supporting this view:

• Economic growth. GDP performance has consistently exceeded its long-term trend since the third quarter of 2022. According to the consensus, the GDP for the third quarter of 2023 is estimated to have expanded by an annualized 4.5% (compared to 2.1% in the second quarter of 2023). Notably, job growth turned out to be stronger than anticipated during this period, with an average of 266,000 new jobs created each month. A robust labor market, along with a slowdown in inflation, suggests that consumer spending is less vulnerable than previously thought. This holds true even though a significant portion of the savings accumulated during pandemic-related stimulus measures has already been spent.
• Inflation. Core inflation, which excludes food and energy prices, has been decreasing in recent months despite robust economic growth. The core inflation rate of 4.1% recorded in September was the lowest in two years. Core goods inflation reached zero, implying that all inflation was driven by services, with shelter being the most significant contributor. When excluding this component, both core and headline inflation remained at moderate levels around 2%. Data related to new rental agreements indicates that housing inflation, which typically lags new agreements by approximately 12 months, may slow down in the coming months, eventually leading to a more significant reduction in headline inflation.
• Monetary Policy.  Projections from the Federal Reserve’s September meeting showed that the majority of participants anticipate a further increase in interest rates by the end of 2023. Given robust job growth and inflation that, although decelerating, remains above the Federal Reserve’s target, the question arises: why not raise interest rates? One factor that might make a further increase less likely is the substantial adjustment in long-term bond yields (the yield on the 10-year bond has risen so sharply that it now trades above 5%, a level not seen since July 2007). There is a strong consensus that rates are well above neutral, suggesting that inflation will eventually return to its target if the Federal Reserve simply maintains rates at their current levels. Considering the uncertainty surrounding future economic conditions, it is believed that the Federal Reserve may opt to keep rates unchanged and monitor the evolution of new economic and financial data.

Growth has been above trend since the third quarter of 2022 

Note: The graph shows GDP performance at annualized quarter-over-quarter rate and annual change (%). 

Source: UBS 

The consumer price index (CPI) increased by 0.4% in September (compared to 0.6% in August), resulting in an annual inflation rate of 3.7% (exceeding the expected 3.6% and unchanged from August). As for core CPI inflation, which excludes volatile components such as food and energy, it remained stable with respect to the previous month and reached 4.1% annually. This represented a notable improvement from August’s 4.3%.

As for the breakdown of the report, the gasoline component increased by 2.1% in the month (up 3% annually), although it significantly slowed down from August’s 10.6%. The category that includes all energy increased by 1.5% on a monthly basis, although it registered a slight contraction of 0.5% in its annual rate.

Surprisingly, the shelter index continued to advance. This category, which represents the largest average U.S. household expenditure, contributed more than 70% of the total increase in the core CPI over the past twelve months and was the most significant factor in the latest monthly change. September saw a 0.6% increase (up 7.2% annually), the highest since May of this year. Further detailing, residential rents were up 0.6% monthly (up 7.2% annually), principal residence rents were up 0.5% monthly (up 7.4% annually), and the property owner equivalent rent, which indicates what owners believe they could get for their properties, was up 0.6% monthly (up 7.1% annually).

Finally, the services category (excluding energy services) increased by 0.6% in the month, resulting in an annual figure of 5.7%, while food registered a total monthly change of 0.2% (up 3.7% annually). Noteworthy, food away from home continued to experience pressure with a monthly increase of 0.6% (up 6% annually).

Overall, the trend in inflation continues to show improvement since the peak reached in June of last year, when the annual rate reached 9.1%, the highest in approximately 40 years. However, as we have mentioned on previous occasions, there is still room for improvement, especially with regard to services (excluding energy services) and shelter. 

It is important to keep in mind that gasoline prices could increase in the short term due to tensions in the Middle East. It is also relevant to consider that the September employment data was quite strong. In this context, consensus probabilities for the upcoming November and December announcements broadly consider for now that there will be no further increases to the reference rate. However, the tone of a restrictive environment could be maintained, given that this was expressed in the minutes of the last meeting of the Federal Reserve, pointing out that there was unanimity that policy will remain restrictive until there is greater clarity that inflation is firmly on its way to the 2% target, without ruling out the option of a new hike before the end of the year.

CPI monthly change (%) over the last twelve months

Source: U.S. Bureau of Labor Statistics

Change (%) in the last twelve months in CPI and Core CPI

Source: U.S. Bureau of Labor Statistics

The robust September employment report briefly pushed up long-term government bond yields, prompting investors to rethink their short-term expectations for interest rates. Since late June, the 10-year Treasury yield has risen from 3.8% to 4.8%, coming close to hitting approximately 5%, the highest level since June 2007. Over the past fifteen years, following the global financial crisis, the yield on the 10-year Treasury bond has ranged between 1.5% and 3.0%.

The initial phase of this rise in yields, as mentioned earlier, was driven by economic strength and the possibility of a soft-landing despite the Federal Reserve’s tightening policy. This contrasts with the predominant view earlier in the year, which anticipated a significant economic slowdown. However, as evident from the robust employment report for September, which saw the creation of 336,000 jobs (revised up from 227,000 in August), and an unchanged unemployment rate at 3.8%, this expected slowdown has not materialized. However, wage compensation increased at its slowest rate since mid-2021, at +4.2% annually.

On the other hand, the expectation of a prolonged period of higher federal funds rates, as revealed in the Federal Reserve’s September forecasts (5.1% by the end of 2024, up from 4.6% projected in June), coupled with rising oil prices, the Quantitative Tightening (the normalization of the Federal Reserve’s balance sheet), and the possibility of a further downgrade in the US credit rating, are among the factors contributing to this yield rebound. The next market-moving event will be the September inflation report, which is expected to show an annual rate of 3.6%, a slight deceleration compared to the previous month.

Given this complex mix of factors and variables, it’s not unreasonable to anticipate that we may continue to see elevated interest rates for an extended period. Some analysts even suggest that government bond yields could potentially range between 3% and 5%. The lower end of this range is considered plausible unless a severe recession materializes, a scenario not currently being factored in due to the robust labor market.

That being said, there still appear to be attractive entry points in the fixed-income market, particularly for investment-grade (IG) bonds (due to their lower correlation with the stock market) with maturities ranging between 5 and 10 years, where the spreads compared to US treasuries look enticing (credit premiums).

Historical yield on the 10-year Treasury bond.

Source: morningstar- Federal Reserve