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From debt ratios to interest rates to unemployment, simple averages of the past are often not a good guide to where things are headed.

One of the frustrations of the post-GFC period was the way some people (and international agencies) assumed that historical averages of key ratios like housing prices or debt to income defined ‘normal’. If one of these macro ratios was well away from that historical average, it was an ‘imbalance’ that needed to be corrected, it was claimed.

The problem with this idea is that often the metric in question does not have a ‘right’ level that prevails through time. In the case of the economy-wide ratio of household debt to income, the sustainable ratio is higher in recent decades than it was back in the 1970s and 1980s. If inflation – and so nominal interest rates – falls permanently, the sustainable debt-to-income ratio rises, because households can service a larger loan with the same repayment. Financial deregulation also removed other artificial constraints on borrowing that prevailed back then.

This point has been well understood for more than 20 years, having been written about by various RBA staff members (including me) all those years ago. Yet still one hears concerned comments that once upon a time you could only borrow four times income, and now you can borrow a much higher multiple. And it’s true, because once upon a time inflation averaged 6–8% and mortgage rates were double-digit, but not anymore.

The misunderstanding was even more frustrating because, often, the historical averages used were based on data sets that went back to 1980. Since Australia was later to join the low-inflation club than many of its peers, more of the period since 1980 was in that high-inflation-low-debt era. That drags the historical average lower, making the recent data look higher in comparison than for other countries that already had inflation down by the early 1980s. That Australia looks ‘worse’ on these metrics is mainly a statistical artefact.

There is a broader point here: historical averages do not always represent centres of gravity to which the world must somehow return. Many of the metrics in question are emergent properties of the economic system and not bound to return to a particular number. We have made this point before, regarding the structure of interest rates globally and the sustainable level of the unemployment rate.

Part of the issue is that even if people behave similarly to the past, the macro-level averages and ratios that come out of that behaviour might not be the same as in the past. The composition of the population might have changed, or some other factor that changes the macro-level outcome. Certainly, the age structure of the population has changed. Population growth rates also do not stand still; in Australia, population growth has been noticeably faster post-GFC than pre-GFC. This has implications not only for labour market variables, but also things like the required rate of home-building each year.

Things aren’t the same after a shock

The question of where ‘normal’ is becomes especially salient when you are coming out of a large shock like a pandemic. It is tempting to look at the pre-pandemic period as the benchmark for where things are likely to return, but this is probably a mistake.

The reality is that the pre-pandemic period wasn’t ‘normal’ either. There was considerable labour market slack in Australia at the time. Wages growth consistently undershot RBA and other forecasts. Inflation lagged below target despite what appeared to be very expansionary monetary policy.

There was something going on beyond the national level, too. Many peer economies were finding that unemployment rates could decline to levels not seen in decades without wages growth or inflation picking up materially. Global rates and risk spreads were also far from normal, compressed to extreme levels. If someone had told me at the beginning of my career that large parts of the European corporate bond universe would have negative nominal yields for a sustained period, I would never have believed them.

Another decidedly non-normal feature of the period between the GFC and the pandemic was that business investment in many advanced economies (including Australia) lagged historical averages. So did trend productivity growth. These trends were probably related, with some researchers hypothesising that this was a consequence of the financial crisis, and the associated weak demand and debt overhangs.

The upshot is that the global economy had probably barely completed the adjustment to the previous big shock, the GFC, before being hit by the next one, the pandemic.

Make the trend your friend

How can you forecast, or even interpret current events, when the ground is shifting in this way?

One approach is to focus on the underlying behaviour at a more micro level and let the implications for macro variables flow from that. For example, forecasts of consumption are typically based on past experience of people’s spending responses to additional income. This approach won’t always predict actual outcomes: as Westpac Economics colleague, Economist Jameson Coombes reported yesterday, the recent data from the Westpac–DataX Consumer Panel is pointing to a smaller spending response to the Stage 3 tax cuts than the historically typical response. But it is better than playing chartist with macroeconomic ratios by assuming that consumption reverts to a ‘normal’ share of income.

It is also useful to factor in any longer-term trends that are in evidence. The trends in the labour market are a case in point. In addition to the stronger average population growth, the participation rate has been trending up for decades and this shows no signs of ending.

If population growth is stronger than it used to be in decades past, then employment growth needs to be higher to keep pace, too. And if the participation rate is trending up, employment growth needs to outpace working-age population growth to avoid rising unemployment. Some observers have interpreted recent rapid growth in employment as a sign that the labour market is still strong. But it could equally be viewed as being insufficient to keep pace with the even faster growth in labour supply.

It all depends on what your view of normal is.

The US stock markets have steadily climbed since the 2008 financial crisis, achieving a remarkable 740% growth between 2009 and 2024. This upward trajectory, while occasionally disrupted by events like COVID-19 and the Ukraine War, has consistently rebounded, defying recession predictions and showcasing market resilience. The S&P 500’s performance since 2008 is illustrated in the chart below, highlighting some of key events that potentially impacted the market. Despite these events, the upward trend has persisted through various political administrations, fiscal policies, and fluctuating interest rates.

Source: Tradingview.com

The Equity markets in general are driven by multiple different factors, some of the main drivers are a sector’s performance, company’s earnings, potential future growth, how much investors value a stock and are willing to pay for it. However, businesses need a friendly economic environment to thrive, and the overall health of the US economy can have a major impact on businesses which is then reflected onto the stock market indices such as the S&P 500.

What are some of the key economic indicators to gauge the health of the US economy?

By monitoring these indicators, market participants can gain a better understanding of the economy’s current state and potential future direction, which helps them make informed investment decisions.

Inflation

Inflation is the general increase in the prices of goods and services over a period of time, higher inflation reduces the spending power of a currency over the long term and can significantly impact economic growth.

• Firstly, when inflation is high, businesses often face higher interest rates on loans. This is because lenders typically adjust interest rates to reflect the increasing cost of living. Higher interest rates make it more expensive for businesses to borrow money, which can limit their ability to invest in new projects, expand operations, or hire more employees. As a result, businesses may experience slower growth or even be forced to scale back their operations.
• Secondly, inflation also affects consumer spending. When prices rise, consumers may have less disposable income as a larger portion of their budget goes toward essential expenses such as housing, food, and transportation. This can lead to consumers becoming more selective with their spending, opting for cheaper alternatives or postponing non-essential purchases. As a result, businesses that rely on consumer spending may experience a decline in sales and revenue, further impacting overall economic growth.
• Additionally, inflation can disrupt long-term planning and investment decisions, as businesses and individuals become more uncertain about the future value of money. This uncertainty can lead to a reluctance to commit to major projects or investments, further slowing down economic growth.
• Therefore, policymakers and central banks often prioritize controlling inflation to maintain stable economic conditions and foster sustainable growth. Measures such as raising interest rates, adjusting monetary policies, and implementing targeted interventions may be employed to curb inflation and mitigate its negative effects on businesses and consumer spending.

In the US, the Federal Reserve’s inflation target rate is 2%, this percentage can stimulate spending which keeps the economy growing. However, if inflation is higher than wage growth, it can be a sign of a struggling economy.

The US Consumer Price Index is an economic indicator that measures inflation in the US, it measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The indicator comes in different forms, the Core CPI provides data that excludes volatile components like energy and food products. Other inflation indicators are also watched closely by traders such as Core Personal Consumption Expenditure (Core PCE) , the FED’s preferred inflation gauge.

Source: Bloomberg Terminal

As indicated on the above chart, the US CPI has been fluctuating around the 2% level from 2008 till early 2021, in some cases, it was as low as -2.0% and as high as 5.0%, mostly affected by the impact of the 2008 financial crisis as well as the sharp swings in energy prices, however, the Core CPI and Core PCE remained stable around the 2.0% level for the same period.

Following the COVID19 Pandemic, global inflation rose significantly, CPI reached 9.1%, Core CPI 6.6% and Core PCE 5.6%. In March of 2022, the Federal Reserve raised interest rates for the first time since 2018 and continued its interest rate hike path up to 5.25% – 5.5% range. The US CPI is currently at 3.4%, Core CPI at 2.9% and Core PCE at 2.6%

As inflation began and continued to decline over the past 2 years. The FED pivoted in December of 2023, stopped raising rates and kept the markets on hold anticipating the FED’s first rate cut which took place on September 18th, 2024 when the FED cut interest rates by 50 basis points, setting the current FED Funds Rate at the range of 4.75% – 5.0%.

According to Bloomberg’s Analysts surveys, economists see US Inflation reaching the Federal Reserve’s target early next year, the surveys show that the PCE gauge averaging 2.1% in early 2025.

Job Market Data

Job market data includes employment figures and unemployment rates, which indicate the strength of the labor market and the overall economic health. Traders in general pay attention to Non-Farm Payrolls and Unemployment Rate.

The Non-Farm Payrolls (NFP) is a key economic indicator that measures the number of jobs added or lost in the US economy, excluding the farming sector. Following the spikes in job numbers caused by COVID19, the Non-Farm payroll figures continued to beat expectations over the past few years, reflecting the strength of the US economy as more jobs were added. However, the number of added jobs has recently stabilized, sending warnings of a potential slow down.

The Unemployment Rate currently hovers around 4.1%, its latest reading for September 2024. Over the past few years, and as the world was getting out of COVID restrictions, the unemployment rate in the USA declined to some of its historic lowest levels reaching 3.4%, reflecting the strength of the US economy and supporting a slower FED in its rate cut path.

FOMC – Monetary Policy and Interest Rates

The Federal Reserve’s interest rate policy affects the US economy by influencing borrowing costs, spending, and investment. Lower interest rates encourage borrowing and spending, stimulating economic growth. Conversely, higher interest rates can slow the economy by making borrowing more expensive. The Federal Reserve uses its interest rate policy to manage inflation and promote economic stability.

The FED, same as other global central banks, have said multiple times that any interest rate decisions will be data dependent, and that the FED continues to monitor the markets closely, aiming to keep inflation under control within a sustained economic growth environment.

Source: CME Group

The next upcoming FED meetings for 2024 and early 2025 are scheduled for November 7th, 2024, December 18th, 2024 and January 29th, 2024. According to the most recent review of the CME FedWatch tool, market participants still anticipate an average of three x 25 basis point interest rate cuts between November 7th, 2024, and January 29th, 2025, however, at lesser percentages than seen in prior weeks. For the November 7th, 2024, meeting, the percentage of participants expecting a 25-basis point rate cut stands at 93.0%, while those expecting rates to remain on hold stands at 7.0%. As for the December 18th, 2024, Fed’s meeting, the percentage of a further 25-basis points rate cut currently stands at 69.8%.

What are the potential risks facing the US stock market in the current market environment?

Some examples of the potential risks may include but are not limited to:

• Interest Rate Uncertainty: The market is divided on future Fed rate cuts, causing uncertainty and potential volatility.
• Economic Data Sensitivity: Upcoming data releases could cause market reactions if they deviate from expectations.
• Political Pressure: The US elections risk, and the fact that some politicians were calling for more aggressive rate cuts, which could influence the market sentiment around the FED decisions.
• Global Factors: The potential impact of global events on the US stock market.

Remember, these are just some potential challenges. The market is constantly influenced by a wide range of other major factors such as companies earnings, growth as well as many other factors.

Technical Analysis SPX500 Weekly Chart

Source: Tradingview.com

• As previously mentioned, the S&P 500 Index has been in an uptrend since the markets got out of the financial crisis in 2008, the long term uptrend faced multiple hiccups along the way, however, the index was able to resume its uptrend reaching historic highs.
• The MACD indicator reflects that the price action deviation from its moving averages has remained near its widest points for an extended period, and currently has a negative divergence to price action for the later part of the uptrend, suggesting weakness in the ongoing trend, marked by the red lines. The MACD line remains above the signal line, however, it is yet to break below it.
• Price action is currently finding resistance along its Monthly R1 standard calculation of 5904, a weekly close price near the 5780 area, will complete a bearish engulfing candle on the weekly timeframe.
• A confluence of support lies below the price, represented by the EMA9 and the SMA9  intersecting with the monthly pivot point 5645.4, a second confluence of support lies below, represented by the SMA21, the redline lower channel border and the monthly S1 standard calculation of 5506.4.

Market Sentiment – COT

Source: cotbase.com

The COT report for the week ending on Friday, October 18th, 2024 (Includes data up to the end of day Tuesday, October 15th, 2024) reflects the following:

• Asset Manager/Institutional position levels have been in line with price action since early 2020 (Blue lines). However, as the long position level historic extremes were reached, a negative divergence can be seen between price action and Asset Manager/Institutional positions. Price action is making higher highs, while Asset Manager/Institutional’ long positions are making lower highs (Red lines), suggesting a potential change in sentiment.
• The latest COT report also reflects a discrepancy, the positions data reflects that Other Reportables are moving towards sell while the Small Speculators category are moving towards long.

In conclusion, the US stock market’s future trajectory is contingent upon a multitude of factors, including economic indicators, Federal Reserve policy, and global events. While the market has demonstrated resilience in the face of past challenges, investors must remain vigilant and adaptable in this evolving landscape. By carefully considering economic data, technical analysis, and market sentiment, investors can position themselves to navigate the next chapter of the US stock market with greater confidence.

• S&P 500 index reversed from support zone
• Likely to rise to resistance level 5900.00

S&P 500 index recently reversed up from the support zone located between the key support level 5785.00 (former top of wave 1 from September), 20-day moving average and the 50% Fibonacci correction of the upward impulse from the start of October.

The upward reversal from this support zone is likely to form the daily Japanese candlesticks reversal pattern Morning Star Doji.

Given the clear daily uptrend, S&P 500 index can be expected to rise toward the next resistance level 5900.00 (which reversed the index earlier this month).

• EURCAD reversed from support zone
• Likely to rise to resistance level 1,5000

EURCAD currency pair recently reversed up from the support zone located between the key support level 1.4900 (former resistance from June), lower daily Bollinger Band and the 50% Fibonacci correction of the upward impulse from June.

The upward reversal from this support zone is likely to form the daily Japanese candlesticks reversal pattern Morning Star Doji.

Given the strength of the aforementioned support zone, EURCAD currency pair can be expected to rise toward the next resistance level 1,5000 (which reversed the price in the middle of this month).

At an event today, BoE MPC member Catherine Mann highlighted the ongoing challenges with services inflation, stating that it still has "a long way to go" before it reaches the target-consistent level. Despite cooling to the lowest point in over two years, Mann emphasized that services inflation needs to fall to around 3% to align with BoE’s 2% inflation target.

She cautioned that structural persistence in wage-price dynamics could delay rate cuts, noting, "If you have structural persistence in the relationship between wages and price formation, it’s premature to start cutting until you purge those behaviors."

Additionally, Mann warned that interest rates are likely to settle higher than pre-pandemic levels due to persistent inflationary pressures driven by supply shocks and labor market frictions. She added that there is likely to be "a lot more inflation" moving forward.

Markets

EUR/USD tested 1.0778 for a second straight session as disappointing French PMI surveys kicked off European dealings. The French composite PMI got stuck deeper in recession territory (47.3 from 48.6) while consensus expected a minor improvement compared to last month (48.9). With the French business surveys however, the worse (European) news was immediately digested. German PMI’s showed an unexpected improvement (composite 48.4 from 47.5 vs 47.6) and both countries accounted for the second consecutive (minor) drop in business activity on an EMU level (composite 49.7 from 49.6). The rest of the eurozone saw output increase at the fastest level in four months. Output was scaled back in response to a weakening demand environment, with new orders down for the fifth consecutive month. Companies responded to lower workloads by reducing employment to the largest degree in almost four years (centred on manufacturing, near stagnation in services), while business confidence dropped to an 11-month low. There was again a divergence between manufacturing (45.9 from 45) and services (51.2 from 51.4). Input costs increased again, but the pace of inflation eased further and was the lowest in just under four years. Output prices rose at a modest pace that was the slowest since February 2021, as a rise in services charges just outweighed a fall in manufacturing selling prices. Higher services costs nevertheless remain a worry for the ECB. While PMI’s obviously were a grim reading, at least they didn’t deteriorate further or drop below consensus estimates. While we still get the November surveys, the October release justifies another 25 bps rate cut by the ECB in December instead of an acceleration to 50 bps. EUR/USD “rebounded” towards 1.08 with front end European yields coming off the intraday lows. At the time of writing, German yields remain 4 to 5 bps lower across the curve though. US eco data included an unexpected decline in weekly jobless claims (227k from 242k vs stabilization expected) and slightly better US PMI’s. Manufacturing remains mired in recession (47.8 from 47.3) while services are strong (55.3 from 55.2). Details showed robust output and sales growth while selling prices rose at the slowest rate since May 2020. Businesses nevertheless remain cautious about hiring, leading to a third month of modest payroll reductions. PMI’s didn’t trigger a directional market move.

News & Views

Czech National Bank policymaker Jan Prochazka broke the relative silence surrounding the central bank lately. Prochazka said that weaker growth abroad and a slow domestic demand recovery would allow the CNB to keep cutting the policy rate (4.25%) but warned for potential inflation hotspots. Money markets currently expect about two more 25 bps cuts at each of the remaining meetings this year. The November 7 one will showcase updated forecasts as well as potential changes as to how they are made and communicated based on external reviews that are underway. Prochazka said he expected a growth downgrade for 2025, saying the current above-potential 2.8% is too high. A “bad mood” weighs on consumer spending and the external environment (Germany) may worsen in coming months. While inflation is currently within the CNB’s tolerance range (2% +/- 1 ppt), the headline figure may break above 3% again in December. The Czech policymaker was also worried about rising services prices at a pace of around 5%. In its meeting-by-meeting approach the CNB keeps a close eye at the evolution of the CZK as well. The Czech currency trades in a tight sideways trading range around the 2-year lows of EUR/CZK 25-25.5.

UK Chancellor Reeves confirmed in the Financial Times a report that appeared in the Guardian yesterday that cited a senior government source saying she would target a different metric of “debt”. Replacing the current one (public sector net debt excluding the BoE) by the one known as Public Sector Financial Liabilities (PSNFL) would give Reeves additional headroom of >£50bn by the end of the decade under the Treasury’s March forecasts and still have debt falling over five years’ time. Sources said that Reeves would not rush to use all of the extra borrowing though. Nevertheless, today’s clear underperformance of UK gilts compared to German and US peers does reveal some nervousness going into next week’s Budget presentation. UK yields rise 3-4 bps across the curve.

In October, US PMI data showed modest improvement across sectors. Manufacturing PMI rose slightly from 47.3 to 47.8, while Services PMI edged up from 55.2 to 55.3, leading to an increase in Composite PMI from 54.0 to 54.3. These numbers point to a continued expansion of business activity in the US.

Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, noted that October saw business activity grow at an "encouragingly solid pace," with PMI data indicating GDP growth at an annualized rate of about 2.5%.

He added that businesses are increasingly optimistic about the year ahead, particularly in the manufacturing sector. Confidence is improving as companies expect a more stable post-election environment, which could help reverse the current slowdown in production and sales.

Full US PMI release here.

• GBP/USD saw a bounce despite weak UK PMI data, attributed to US Dollar weakness.
• The Bank of England may consider interest rate cuts due to slowing inflation, potentially weakening the Pound Sterling.
• GBP/USD technical analysis shows potential for a bullish bounce, but a break below the trendline could lead to a larger correction.

Cable has enjoyed a decent bounce this morning off a key confluence level. Despite weak PMI data, some US Dollar weakness has helped GBP arrest its slide. Preliminary October Composite PMI in the UK edged lower to 51.7 from 52.6 in October. This begs the question, can Pound Sterling extend its recovery?

October data pointed to a moderate increase in UK private sector output, but the rate of expansion slowed for the second month running to its lowest since November 2023. Survey respondents widely commented on the impact of delayed decision-making among clients and heightened economic uncertainty in October.  Employment was a particularly weak spot, with overall staffing numbers decreasing for the first time in 2024 to date.

Commenting on the flash PMI data, Chris Williamson, Chief Business Economist at S&P Global Market Intelligence said: “Business activity growth has slumped to its lowest for nearly a year in October as gloomy government rhetoric and uncertainty ahead of the Budget has dampened business confidence and spending. Companies await clarity on government policy, with conflicts in the Middle East and Ukraine, as well as the US elections, adding to the nervousness about the economic outlook.

Encouraging for the Bank of England (BoE) is the fact that further cooling of input cost inflation to the lowest for four years opens the door for the Central Bank to take a more aggressive stance towards lowering interest rates, should the current slowdown become more entrenched.

This obviously means that the Pound Sterling may face further weakness as rate cut bets intensify. However, given that the DXY is at extremely overbought levels and GBP/USD is at extremely oversold levels, there is still a chance that Cable may rise back above the 1.3000 and potentially higher as well. A lot of this would hing on how the US Dollar performs over the coming days and weeks.

There are a host of big events over the coming days which could impact markets and relate directly to the GBP and US Dollar. Chief of those being the US election which draws closer with market participants likely to hedge their bets ahead of the big day. This could mean volatility and some whipsaw price action.

On the other end of the pond we have the UK budget on October 30, which is the first from the UK Labour Government. Big tax increases seem likely because of the rising demands on government funds. More investment is on the way, but will it mean even more borrowing? That’s the big question for markets, and Reeves will need to handle it carefully. There are a host of questions which could spark volatility heading into the event as well.

GBP/USD Technical Analysis

GBP/USD had a brief bounce at the back end of last week that failed to break through the 1.3100 handle before pushing lower. This saw cable break below the 100-day MA and finally test the long-term ascending trendline that has been in play since the April 22 lows.

The test of the ascending trendline just below the 100–day MA and key support level do look promising for a bullish bounce. However, the first hurdle would be a daily candle close back above the 100-day MA and then of course the psychological 1.3000 handle.

This would then set the stage for a retest of the resistance area resting just below the 1.3100 range (denoted by the red block on the chart). Acceptance above this level could open up a deeper retracement toward the 1.3250-60 range.

Alternatively, a break of the trendline would be significant and could open up a longer term correction toward the 1.2750 handle for cable. Such a move would hinge on the idea of a continued rally for the US Dollar and DXY in particular. The 200-day MA currently rests around the 1.2800 and could prove key as well.

Later today we have speeches from both Catherine Mann and Andrew Bailey of the Bank of England (BoE) which could stoke some short-term volatility. Any comments around rate cuts etc, may also have a more material impact. This would obviously hinge on what the comments are and where policymakers see rates heading in the months to come.

GBP/USD Daily Chart, October 24, 2024

Source:TradingView.com

Support

• 1.2940
• 1.2800
• 1.2750

Resistance

• 1.3000
• 1.3100
• 1.3250

Daily Pivots: (S1) 151.45; (P) 152.32; (R1) 153.64; More...

Further rally is in favor in USD/JPY with 151.18 minor support intact, despite loss of momentum as seen in 4H MACD. Decisive break of 61.8% retracement of 161.94 to 139.57 at 153.39 will extend the rally from 139.57 to retest 161.94 high. On the downside, below 151.18 minor support indicate short term topping, and turn bias back to the downside for deeper pullback.

In the bigger picture, price actions from 161.94 are seen as a corrective pattern to rise from 102.58 (2021 low). The range of medium term consolidation should be set between 38.2% retracement of 102.58 to 161.94 at 139.26 and 161.94. Nevertheless, sustained break of 139.26 would open up deeper medium term decline to 61.8% retracement at 125.25.