Think before you speak. My favorite news item from last week was buried deep inside an email I received from The Economist on Friday. It included the magazine’s hot take on OpenAI’s latest innovation, OpenAI 01 – a newly released large-language model that claims to use more human-like reasoning by – get this – spending more time “thinking” before it responds.¹

I suppose it’s possible that reminding AI to be more careful with its words qualifies as “innovative” and that this latest evolution was perhaps partially responsible for last week’s big recovery in tech stocks (which, through Friday, has helped repair about half of the damage done to the sector during the summer sell-off). But it’s good advice nonetheless: even those of us who are governed by organically-grown wetware rather than artificially-intelligent software could benefit from a reminder to do a little more thinking before we speak, because words matter. For example, as I write this on Monday morning, futures markets are suddenly pricing in a full 0.50% worth of rate cuts when the Federal Reserve Board (The Fed) meets this week.² That’s a big change from last week when consensus was convinced the Fed would deliver just 0.25%, and there seems to be little more than a Bloomberg editorial from former New York Fed President Bill Dudley to credit for the change-of-heart.³

Mr. Dudley’s argument was well-reasoned, but that’s completely beside the point: when markets are as unsure about something as they are about the size of this week’s rate cut, a single well-placed word from a credible source is enough to move mountains. And moving those mountains can have very real implications: consider, for example, what might happen if the Fed fails to heed Dudley’s advice and instead sticks to the quarter-point cut that markets had assumed all along (or, refrains from cutting altogether...!) The disappointment could be palpable (and might also show up as a visible line item on your next account statement.)

In truth, the market’s sudden willingness to entertain a more aggressive rate cut by the Fed probably had its roots in last week’s inflation data as much as it did Mr. Dudley’s Monday morning editorial. Neither Wednesday’s Consumer Price Index (CPI) nor Thursday’s Producer Price Index (PPI) release was exactly inflation-free, and Wednesday’s slightly-hotter-thanexpected CPI print even caused a mini freak-out that sent most major US equity indices more than a percent lower immediately after it was published. But once economists had a chance to digest some of the details, everyone seemed to realize that last week’s inflation numbers did little to change the conclusion that price growth has finally been (mostly) brought under control by the Fed’s aggressive tightening and markets quickly recovered. (Thursday’s PPI release was more or less a rinse-and-repeat, with the sting of a very small upside surprise in August’s inflation data eased by a downward revision of July’s.)

So if the totality of last week’s inflation data did nothing to change the course of the narrative with regard to prices, what will the Fed do when it releases its decision on Wednesday? If it’s inclined to follow the European Central Bank’s lead, it might be just a quarter-point after all – that’s what Christine Lagarde’s European Central Bank did on Thursday (although to be fair, that was the ECB’s second cut, which might mean the Fed feels it has room to play catch-up.)⁴ But central bankers don’t really think that way: policy decisions are only coordinated in response to big, global crises (and even then bankers are loathe to admit it.)

Regardless, this week’s decision will remain ‘data dependent’, and now that inflation is still clearly riding in the back seat its other data – specifically labor market data – that will drive Fed policy until further notice. Because the Fed won’t get any new jobs data to chew on before it makes its decision, and because weekly jobless claims – last week’s lone labor-related number – was more of a non-event than last week’s inflation data, I’m still skeptical that Powell and a majority of his pals will vote for anything other than a quarter-point.

Of course, there’s every possibility that I could be wrong – in which case you can criticize me for failing to heed OpenAI 01’s clever advice, paraphrased above in the opening words of this week’s Perspective. 

A few odds-and-ends before we move on: small business sentiment failed to build on last month’s improvements and remains at levels more consistent with recession than expansion.⁵ The biggest factor in this month’s slip was a worsening outlook for sales, joining a deeply pessimistic view about future profitability to signal trouble among small businesses that so far hasn’t seemed to infect larger businesses with quite the same vigor. One notable line-item in that report of specific import for Fed-watchers: hiring plans dipped lower and are clearly well past their post-pandemic peak.

Consumers, meanwhile, remain a mixed bag. The University of Michigan’s mid-month update of consumer sentiment ticked slightly higher and now stands at its highest level since May. A slight improvement in plans to purchase durable goods – which collapsed shortly after the Fed began raising rates – was largely responsible for the improvement6 . But it’s safe to assume that at least a portion of those purchases would be made on credit, because last week’s other consumer-related release, the Fed’s so-called G-19 report on consumer credit, showed a troubling surge even as interest rates for both revolving and non-revolving credit remain off-the-chart high.⁷

Finally, longtime readers know that I pay close attention to what banks are saying and doing as an indication of where the economy is headed. That makes last week’s admission by JPMorgan executives (and others) to a group of analysts and investors gathered at a conference that revenue trends are softening and loan performance is faltering potentially noteworthy. While banks came under pressure last week as a result, there was no obvious contagion into the broader market. If weaker trends are indeed afoot for banks, it might pay to be cautious in other areas as well.

What to watch this week

All eyes on the Federal Reserve. 

Wednesday afternoon’s decision on rates will of course capture all the attention this week, with everything else on the macroeconomic calendar falling well down the list. As mentioned above, I still don’t fully buy the argument that a cut of more than 0.25% is needed, nor am I willing to fully ignore the downside risk that a bigger cut might ironically signal (remember the whole “what do they know that we don’t know?” argument?) So a quarter-point still makes the most sense to me, even if Bill Dudley (and futures pricing data) disagrees.

I’m hopeful that markets would take that very much in stride, but we’ll know on Wednesday.

n the meantime, there are still a few things worth watching. Tuesday’s builder sentiment release from the National Association of Homebuilders will set the stage for a week’s worth of housing data that starts with earnings from homebuilder Lennar (also Thursday) and ends toward the middle of next week with home price data and transaction volumes for both new- and existing homes. Of all these, I’d pay closest attention to Lennar’s results and forward guidance – particularly the extent to which the builder is relying on incentives to generate sales. As we’ve said in the past, it would be much easier to build a case for a soft landing and sustainable economic recovery if housing transactions are finally able to reaccelerate now that interest rates are coming off the boil. So far that hasn’t happened, and in my view it’s a race between improving affordability in lane one and a softening jobs market in lane two. The winner will go a long way in determining the health of the US economy into next year.

We’ll also get another peek into the consumer’s willingness to spend when August retail sales data are released on Tuesday. Like Lennar’s results and the insight they could provide into the health of the housing market, you might try augmenting any conclusions you draw from that report with an on-the-ground perspective from Darden Restaurants, set to release earnings on Thursday. Darden operates a wide variety of casual restaurant brands ranging from Olive Garden to Longhorn Steakhouse and a dozen or so in between, and given the portion of retail sales represented by restaurants and bars (roughly 13.6% last month), Darden’s results and guide could be a very interesting peek into the minds of consumers.

On the productive side of the economy, we’ll get our first two regional Federal Reserve manufacturing reports – Empire State on Monday and Philly Fed on Thursday – with Tuesday’s industrial production release thrown in for good measure. The old-fashioned smokestack economy has been underperforming the services sector for months, and these reports will provide evidence to either support or refute that conclusion. Like housing, one of the key determinants of where the economy breaks from here is the direction in which manufacturing and services align: if they can manage to start expanding together, hooray for the soft landing thesis. If they instead align to the downside, look out below. Again, there is an important way to build context around these figures as well: logistics giant FedEx reports earnings on Thursday, too.

Finally, one interesting “one-off” report worth watching for will be Thursday’s Index of Leading Economic Indicators, or LEI. The LEI is a basket of 10 previously-released economic indicators, grouped together by the Conference Board for their collective ability to look forward into the economic future. Recently, the LEI has occupied sort of a no-man’s-land somewhere between expansion and contraction, with economic growth not quite strong enough to claim victory, but also not quite weak enough to signal recession. Watch this week’s release for any evidence of a breakout in one direction or the other.