Gridlock Unplugged: AI's Power Outage

 

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As the U.S. government shutdown has finally come to an end, investors the last two weeks were rattled by a rotation in stock markets: The darlings of the technology and AI sectors, which have driven much of the market gains and earnings growth this year, showed serious signs of fatigue this week. After wobbling through the first two weeks of the month on valuation concerns and a murkier Fed outlook, equities stumbled further, with the Nasdaq shedding roughly 3% and now down 7% from its recent peak. Nvidia’s highly anticipated quarterly earnings didn’t disappoint, but they also didn’t manage to dispel the market’s newfound cautious mood.

On the economics side, the US data dam has finally opened up, and the flow of information is gathering pace (we didn’t get data during the 43-day government shut down). Confusingly, we saw economic releases from no less than four different months this week (all the way from August to November), requiring some deft analysis. But it was the heavily delayed employment report for September that captured most of the attention. While a tad stale, it was nevertheless viewed as an important indication of the economy’s strength heading into the government shutdown, and the last full jobs report the Fed will see before the December 10 US Fed meeting. Alas, it did not clear the muddy waters, as for every strong action, there was an offsetting soft reaction. To very briefly recap:

• Payrolls rose 119,000 in September, more than double expectations and the best since April. But, the prior month was revised down to a drop of 4,000 (from +22,000), and year-on-year growth has slowed to a modest 0.8% pace, the lowest since 2021 (it was 1.3% pre-pandemic).
• Reinforcing the more dovish lean, average hourly earnings nudged up just 0.2% m/m, a tick below consensus. But, there were upward revisions to prior months, leaving earnings up a sturdy 3.8% y/y. That’s still up almost a percentage point from pre-pandemic norms
• Aggregate hours worked edged up just 0.1% m/m, and were about flat for all of Q3. As a key building block for GDP, that alone would point to very modest growth last quarter. But, there are growing signs that the boom in AI spending is lifting productivity, and it still looks like Q3 GDP was solid (around 3%, or even better according to some).
• Finally, the companion household survey (which, sadly, will never be available for October) showed an even stronger job gain of 251,000. But, an even larger increase in the labour force meant that the unemployment rate still rose a tick to 4.4%. That’s the highest rate in nearly four years, and is nearly a point above pre-pandemic levels. Notably, the unrounded rate was higher yet at 4.44%. While the jobless rate isn’t ratcheting higher—it’s only up 0.3 ppts from a year ago, so not in Sahm Rule land—its direction of travel is clear. And, many Fed officials view the rate as the single most reliable indicator of the jobs market.

The bottom line from the murky mix was that the job market is still softening, but not falling off the table. Combined with the wobble in risk assets, this was enough to bring the possibility of a Fed rate cut in December back into play. Even with a variety of Regional Presidents openly questioning the need for another cut just yet, markets now see better than even odds of a trim next month. BMO’s Economics team also expects a December cut for the time being. Perhaps more importantly, the market is almost fully back on board with a broader view of a total of 100 bps of additional easing by the end of 2026, which would take rates to the very low end of what’s now considered neutral. In fact, there was some Fed Speak on Friday morning suggesting their next move was indeed a cut, and that’s what kickstarted Friday’s very welcomed rally.

In sharp contrast to the near-term outlook for the Fed, there is precious little debate on the Bank of Canada. Even those of a more dovish bias would readily allow that with core inflation stuck above 2.5% and a recent upside surprise in jobs, it’s unlikely the Bank will cut anytime soon. This week’s Canadian CPI was a touch on the firm side of expectations at 2.2% y/y on the headline and a meaty 2.7% y/y excluding food & energy. Recall that the headline rate is still flattered by the removal of the carbon tax earlier this year, which carved a bit more than half a point from the total.

On the growth front, there is no clear direction for the Bank of Canada, or at least not enough of a guide to counter the sticky inflation picture. After bravely keeping the economy afloat through the intense trade uncertainty, consumer spending seems to be taking a breather. Retail sales fell 0.8% in volume terms in September, nearly reversing a bounce in the prior month. The see-saw pattern in sales may have been snapped last month, as the preliminary estimate points to a flat result. We’ll get a much clearer picture on growth with the release of Q3 GDP next Friday—expectations are that the economy just managed to eke out 0.5% growth last quarter, and have pencilled in a moderate 1.5% pace for Q4.

 

Source: BMO Economics Talking Points: Stock Theory of Relativity

 

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