Good day. Investors are bracing for the possibility that a second year of stubborn inflation could force the Federal Reserve to bring interest rates higher than they have been in more than 20 years. Some on Wall Street are making a game plan for a fed-funds rate that could hit 6%, the highest since 2000. Meanwhile, the economic troubles in Europe have prompted governments there to keep spending heavily, in contrast with the U.S., which has cut back. But this is putting then on a collision course with the European Central Bank, which has raised interest rates at its fastest-ever pace to cool inflation. 

Now on to today’s news and analysis.

Wall Street pros spent much of this year betting that the Fed’s already aggressive rate moves would quickly cool the economy and stem rising prices. But last week’s better-than-expected jobs report was the latest sign of economic strength to catch investors off guard.

Now, more are seriously considering whether the central bank’s target rate will rise as high as 6% before Fed officials take their foot off the brake—a level not reached since just before the dot-com bust in 2000, and one that could spell far more pain ahead for stocks and bonds.

Economic troubles in Europe have prompted governments there to keep spending heavily in contrast with the U.S., which has cut back. The International Monetary Fund forecasts spending by eurozone governments will reach 51% of the region’s economic output this year, around 4 percentage points higher than in 2019. The splurge is helping to alleviate the economic downturn and might even help control inflation in the short term, but free-spending governments are on a collision course with the European Central Bank, which has raised rates at its fastest pace to cool inflation.

• Live coverage as the midterm election results come in

New York Fed President John Williams hailed how anchored long-term inflation expectations were. Speaking at an event in Zurich, Switzerland, he drew on data including the survey of professional forecasters, the breakeven inflation rates implied by U.S. Treasury securities, the University of Michigan's consumer sentiment survey and the New York Fed's survey of consumer expectations. "The news is mostly good—longer-run inflation expectations in the United States have remained remarkably stable at levels broadly consistent with the FOMC's longer-run goal. Inflation uncertainty has increased, but this does not appear to be due to unmoored longer-run expectations," he said.

—MarketWatch

RBA Deputy Gov. Michele Bullock has indicated the central bank won't deliberately drive the economy into recession in a bid to restore inflation to the 2% to 3% target band. She told market economists after a speech on the economy that the RBA doesn't have a return to target in its current forecasts, saying it was more interested in "preserving" some of the strong employment gains in recent years. Still, if inflation does surprise to the high side, markets shouldn't doubt the resolve of the central bank to bring it back under control, she adds. The RBA has tightened aggressively this year and nobody should doubt its desire to bring inflation back to the target band over time, she said.

—Dow Jones Newswires

10 a.m.: U.S. wholesale trade report for September
11 a.m.: Richmond Fed’s Barkin speaks on economic outlook at Shenandoah University School of Business event

7:30 a.m.: ECB’s Enria participates in De Nederlandsche Bank seminar
8 a.m.: Roundtable discussion with ECB’s Schnabel at Bank of Slovenia
8:30 a.m.: U.S. weekly jobless claims; U.S. consumer-price index for October
8:35 a.m.: Dallas Fed’s Logan speaks at ‘Energy and the Economy: The New Energy Landscape’ conference
9 a.m.: Philadelphia Fed’s Harker speaks on economic outlook to Risk Management Association
11 a.m.: San Francisco Fed’s Daly in virtual fireside chat with European Economics & Financial Centre
12:05 p.m.: Bank of Canada’s Macklem speaks on the evolution of Canadian labor markets
6:30 p.m.: New York Fed’s Williams speaks at ‘Pace Celebrates Downtown Changemakers’

The U.S. economy is “headed for a hard landing,” UBS economists say in a report, noting that, “Household spending has been weak. Households are running down savings. Credit card balances are rising. Goods spending remains very elevated. House prices are falling.” They add that, “The full effects of monetary policy tightening remain to be seen.” The economists see tightening extending into next year, with its impact mounting in coming months with a potential negative loop, as job losses reduce spending, which would curb employment. Facing that scenario, the Federal Reserve would start cutting interest rates next July all the way to 1% in the first quarter of 2024, the economists say.

—Paulo Trevisani

• Confidence among U.S. small-business owners declined in October, driven by worsening short-term expectations amid a deteriorating economic outlook. The National Federation of Independent Business said its small-business optimism index fell from 92.1 in September to 91.3, further below its historical average of 98. The reading matches expectations from economists polled by The Wall Street Journal. (Dow Jones Newswires)
• Japan's new economy minister called on companies to consider higher pay increases ahead of annual wage negotiations next spring. "It is very important to realize sustainable wage increases that can sufficiently cover the rise in prices," Shigeyuki Goto said in a group interview on Wednesday with The Wall Street Journal and other publications. (DJN)
• Eurozone retail sales in September rose despite high inflation squeezing household incomes and depressed consumer confidence. The volume of retail sales increased by 0.4% from August, according to data from the Eurostat statistics agency. (DJN)
• Consumer confidence in Germany and the U.K. stabilized in October compared with the previous month, according to data from decision intelligence company Morning Consult, but any significant rebound looks unlikely amid still high energy prices and a deteriorating economic outlook. (DJN)
• Germany’s economy will suffer a heavy toll from higher oil and gas prices over the 2021-2023 period, the Ifo Institute said in a report. Real income loss over these three years is forecast at almost 110 billion euros ($110.24 billion), or 3.0% of Germany’s annual economic output, Ifo said. (DJN)
• A coming global recession will see sluggish growth or outright contractions in gross domestic product in most major economies, with Europe faring the worst, Capital Economics’ assistant economist Leah Fahy said in a report. The economic research firm forecasts global GDP growth of 1.5% in 2023. (DJN)

This newsletter is compiled by James Christie in San Francisco.

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