The Markets
Adding new ingredients to the economic blender. The performance of United States economy in 2023 has been as unexpected as a lentil-avocado-cinnamon smoothie – a tasty surprise. Last week, economic data suggested the Federal Reserve may need to do more to slow the economy. The consumer price index showed inflation edging higher, wholesale inflation was higher than expected (largely due to higher energy prices), and retail sales were healthy. Stronger-than-expected economic data inspired market optimism that the Federal Reserve will bring inflation down without a recession. However, new ingredients are being added to the economic mix that could prove less palatable. These include:
It's possible these events will result in increased market volatility in coming weeks. Last week, major U.S. stock indices moved lower, according to Barron’s, and yields on longer maturities of Treasuries. The Markets
All the work, work, work. 2023 has been a remarkable year so far. It has, “confounded economists, humbled forecasters, and rewarded investors. Despite a rapid rise in interest rates, the U.S. economy continues to grow. Inflation has fallen – if not quite to desired levels – and stocks have entered a bull market, with the S&P 500 gaining 17% year to date and the Nasdaq Composite up more than 30%,” reported Nicholas Jasinski of Barron’s. One of the biggest surprises has been the strength of the labor market. Over the 12-month period through August 31, 2023, employers added about 271,000 new jobs each month, on average, according to the U.S. Bureau of Labor Statistics. (In August, 187,000 new jobs were created, suggesting some labor market softening.) So far this year, we’ve seen: 4-of-5 prime-age workers working. Last summer, the employment-to-population ratio, which compares the number of people employed to the civilian population of a city, state or country, reached a 20-year high for 25- to 54-year-olds. In June, July and August, the ratio was 80.9 percent, according to the St. Louis Federal Reserve (SLFR). “This ratio is a good barometer of the overall health of the labor market because it excludes younger people who are more likely to be in and out of school as well as older people who may be retired,” reported Stephanie Hughes of Marketplace. The employment-to-population ratio for women hit a record high. In the second quarter, the employment-to-population ratio for women reached 75 percent – a new record. Three-of-4 women, ages 25 to 54, were employed, according to the SLFR. “Women are crushing it in the labor market right now – their return to work from the pandemic has been faster than men’s…A big part of this is the rise of remote and flexible work, which has enabled a record number of women with young children to enter or remain in the workforce,” reported Emily Peck of Axios Markets. The labor force participation rate increase. The labor force participation rate – the number of people who are employed or are seeking employment – remained stubbornly low even after the U.S. economy reopened following pandemic closures. In August, the labor force participation rate increased to the highest level since the pandemic. “The labor market continues to rebalance in a healthy direction. The U.S. economy is still adding jobs…And, for employers, there are now more workers available per open positions, and wage pressures are abating,” reported Jasinski of Barron’s. Last week, major U.S. stock indices moved lower when economic data raised concerns the Fed may need to raise rates again, according to Barron’s. In the Treasury market, the yield on the 30-year U.S. Treasury bond finished the week at 4.3 percent. The Markets
Lowering inflation. If you’ve ever waited in traffic while the center section of a bridge lifts to allow ships and sailboats to pass underneath, you may have noticed the enormous counterweight that lowers as the bridge moves higher. When the boats have passed, the counterweight rises, and the bridge lowers back into place. The Federal Reserve (Fed) often acts as a counterweight to the economy; raising and lowering interest rates to achieve its goals. Recently, the Fed has been raising rates to bring inflation down. Higher rates make borrowing more expensive, slowing economic growth and reducing demand for goods. Over the past 18 months, the Fed has raised the effective federal funds rate from near zero to 5.33 percent. Last week, data suggested its efforts were working. The Personal Consumption Expenditures Price Index showed that headline inflation has dropped from a peak of 6.8 percent in June of 2022 to 3.3 percent in July 2023. In addition, last week’s employment report showed jobs growth slowed in August. In an interesting twist, despite more jobs being created, the unemployment rate rose from 3.5 percent to 3.8 percent. It rose because the labor force participation rate increased as more people returned to the workforce and looked for jobs. “This was a more complicated report than recent months’ with lots of cross-currents. Overall, it supports the soft-landing thesis for the economy, as the labor market is easing without major layoffs and wage dips…This seems like an ideal report for the Federal Reserve. Wage gains are coming down and payrolls are rising but at a much slower pace,” reported Katia Dmitrieva of Bloomberg. Last week’s data left many believing the Fed will leave rates unchanged in September; however, there was disagreement about whether the Fed will remain on pause, resume rate hikes, or lower rates in the months ahead. Markets embraced the idea of a Fed pause in September, and major U.S. stock indices moved higher last week, according to Barron’s. In addition, the yield on the one-year U.S. Treasury bill finished the week at 5.4 percent. Labor Day Holiday Hours:
Friday, 9/1, our office will be closed at noon. However, our telephone will be monitored until 4pm for urgent requests. Monday, 9/4, our office will be closed for Labor Day. The Markets Becalmed. The Chinese government’s zero-COVID policy took the wind from the sails of its economy. When the government finally ended the policy earlier this year, many economists anticipated that pent-up consumer demand would refill China’s economic sails, lifting the global economy, reported Malcolm Scott of Bloomberg. Instead, China’s economy is in an economic doldrum, recovering far more slowly than anyone anticipated. As a result, economists have steadily lowered 2023 growth forecasts for the country, reported Yahoo Finance and Diane King Hall. The economy isn’t well-positioned to move ahead. From April through June, it advanced a desultory 0.8 percent. Unemployment among young people is so high that China stopped releasing the data in July, reported Minxin Pei of Bloomberg. In addition, a banking crisis may be on the horizon as China’s real estate sector, which comprises about 20 percent of the country’s economic growth, is experiencing a downturn. Also, government stimulus may be limited as China’s debt-to-GDP ratio is about 300 percent; the highest among emerging markets, reported economist Tao Wang in an interview with Vincent Ni of National Public Radio. Recently, China attempted to stimulate growth and restore confidence by cutting a key interest rate, but investors were not impressed. The benchmark CSI 300 Index, which tracks the performance of 300 A-share stocks traded on the Shanghai Stock Exchange or the Shenzhen Stock Exchange, has fallen by 9 percent in recent weeks as overseas investors moved more than $10 billion away from Chinese stocks, reported Xie Yu and Yoruk Bahceli of Reuters. Meanwhile, the U.S. economy continues to grow faster than anticipated. “Despite umpteen predictions of a slowdown, it keeps going and going. Recent data suggest it may even be on track for annualized growth of nearly 6% in the third quarter, a pace it has hit only a few times since 2000,” reported The Economist via Yahoo Finance. The strong U.S. economy has impeded efforts to lower inflation. Last week, Federal Reserve Chair Jerome Powell confirmed that U.S. inflation remains too high. “As is often the case, we are navigating by the stars under cloudy skies…At upcoming meetings, we will assess our progress based on the totality of the data and the evolving outlook and risks…we will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data,” Powell said. His comments were generally well-received. The Standard & Poor’s 500 and Nasdaq Composite Indices finished the week higher, while the Dow Jones Industrial Average moved lower, according to Barron’s. Yields on shorter-maturity U.S. Treasuries generally moved higher over the week. The Markets
Higher bond yields may be good for income investors – and not so good for stock markets. After more than a decade of near-zero interest rates, the “free money” era – a time when people and businesses could borrow money and repay it with very low (or no) interest – may be over. Last year, rising inflation caused the Fed to begin raising the federal funds rate aggressively. Yields on bonds moved higher, too. At the end of last week, the yield on a one-year U.S. Treasury bill was 5.35 percent, up from only 0.40 percent at the start of 2022. Many people thought rates and bond yields would come back down relatively quickly, but that school of thought is changing, reported Michael Mackenzie and Liz Capo McCormick of Bloomberg. “All around the world, bond traders are finally coming to the realization that the rock-bottom yields of recent history might be gone for good…The surprisingly resilient US economy, ballooning debt and deficits, and escalating concerns that the Federal Reserve will hold interest rates high are driving yields on the longest-dated Treasuries back to the highest levels in over a decade. That’s prompted a rethink of what ‘normal’ in the Treasury market will look like…strategists are warning investors to brace for the return of the ‘5% world’ that prevailed before the global financial crisis.” Higher bond yields may be good news for income-oriented investors who turned to dividend-paying stocks for income when bond yields were low. Now, those investors may be able to earn attractive yields with lower-risk Treasuries, reported Al Root of Barron’s. It’s not such great news for stock markets, though. “…rising Treasury yields are a problem for stocks because investors will rotate out of riskier equities and into less-risky bonds because the additional return in stocks isn’t worth the volatility,” stated a source cited by Teresa Rivas of Barron’s. Last week, major U.S. stock indices finished lower, while yields on longer-term U.S. Treasuries moved higher. The Markets
Consumer sentiment is a lagging indicator. It’s also a contrarian indicator. After rising sharply in June and July, consumer sentiment leveled off this month. The preliminary August reading for the University of Michigan Consumer Sentiment Index was 71.2. That’s slightly below July’s reading, although it’s up 22.3 percent year-over-year, and up 42 percent from its all-time low of 50 (June 2022). The historic average for the Index is 86. “In general, consumers perceived few material differences in the economic environment from last month, but they saw substantial improvements relative to just three months ago. Year-ahead inflation expectations edged down from 3.4% last month to 3.3% this month, showing remarkable stability for three consecutive months,” wrote Surveys of Consumers Director Joanne Hsu. The University of Michigan Consumer Sentiment survey provides information related to:
Consumer sentiment is a lagging indicator because it can take several months for changes in economic activity to be felt by consumers. This type of sentiment also is considered a contrarian indicator. John Rekenthaler of Morningstar explained, “When people are deeply unhappy, stocks are likely to thrive, because the economic damage that bothers them has already occurred. A contented populace, on the other hand, is the investment equivalent of red sky at morning. Equity shareholders, take warning.” Mixed inflation data caused markets to stumble last week. The Standard & Poor’s 500 and Nasdaq Composite indices finished lower, while the Dow Jones Industrial Average moved slightly higher, reported Barron’s. Yields on U.S. Treasury notes and bonds rose. The Markets
An unwelcome surprise. Last week, Fitch Ratings startled markets by lowering the credit rating of United States Treasuries from AAA to AA+. It was the second rating agency to downgrade U.S. Treasuries; Standard & Poor’s cut its rating to AA+ in 2011, reported Benjamin Purvis and Simon Kennedy of Bloomberg. The decision to lower the rating was not a comment on the strength of the U.S. economy, which expanded faster than expected in the second quarter on the strength of business investment in equipment, particularly transportation equipment, reported Erik Lundh of The Conference Board. While many were baffled by the decision, as well as its timing, Fitch had warned it was considering a rating downgrade in May when lawmakers were haggling over the debt ceiling while the possibility of default loomed, reported of Bloomberg. Last week, Fitch Senior Director Richard Francis told Davide Barbuscia of Reuters, “Fitch downgraded the U.S. credit rating due to fiscal concerns, a deterioration in U.S governance, as well as political polarization reflected partly by the Jan. 6 insurrection.” There are now 10 countries with government bonds that are rated AAA by at least two rating agencies: Germany, Denmark, Netherlands, Sweden, Norway, Switzerland, Luxembourg, Singapore, Australia, and Canada, reported Tania Chen of Bloomberg. Markets did not take the downgrade well. Stocks sold off and Treasury rates rose mid-week. Jacob Sonenshine of Barron’s reported: “Of course, the [stock] market always needs a reason to fall, and this past week it found one in surging Treasury yields. It’s hard to tell exactly what made them pop. Though some blamed Fitch’s downgrade of the U.S. credit rating to AA+ from AAA, it’s more likely a combination of massive issuance—the Treasury said it plans to issue more debt than had been expected—and solid economic data that forced market participants to reconsider their growth targets. Higher yields make stocks worth less, all else being equal.” Markets briefly reversed course later in the week when the U.S. employment report showed jobs growth easing. Overall, employment data supported the idea that a recession may be avoided. The number of new jobs created remained above the pre-pandemic monthly average, and average hourly earnings were up 4.4 percent year-over-year, according to Barron’s Megan Leonhardt. At the end of the week, major U.S. stock indices were lower, reported Barron’s. Yields on longer U.S. Treasuries rose more than yields on most shorter Treasuries, steepening the yield curve. The Markets
Central bank palooza! While music lovers attended concerts and festivals across the United States, central banks had a lollapalooza of their own. The U.S. Federal Reserve (Fed) led things off last Wednesday, followed by the European Central Bank (ECB) on Thursday, and the Bank of Japan (BOJ) on Friday. Here’s what happened: The Fed continued to play a familiar tune at July’s Federal Open Market Committee (FOMC) meeting, raising the effective federal funds rate from 5.08 percent to 5.33 percent. Fed Chair Jerome Powell stated, “Inflation remains well above our longer-run goal of 2 percent…Despite elevated inflation, longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets.” In addition to raising rates, the Fed is engaged in quantitative tightening (QT) – selling assets, or letting them mature, to reduce the Fed’s balance sheet. Like rate hikes, QT is intended to slow economic activity and the pace of inflation. Currently, the Fed is reducing its balance sheet by about $60 billion a month. The ECB was singing the Fed’s tune. It lifted rates from 3.50 percent to 3.75 percent, reported CNBC. In the European Union, the inflation rate was 5.5 percent in June, down from a high of 8.6 percent last summer. Prices are rising at the slowest pace in Luxembourg (1.0 percent, annualized) and the fastest in Hungary (19.9 percent, annualized). The BOJ sent a shiver through markets when it unexpectedly changed its yield curve policy, while leaving its short-term policy interest rate unchanged. For years, Japan’s central bank has kept rates very low to encourage spending and investment. The change in its policy caused yields to surge higher, reported Toru Fujioka, and Sumio Ito of Bloomberg. The surprise move is important because, “Japanese investors have spent more than $3 trillion offshore in search of higher yields. Economists warn that even a small shift to policy normalization may prompt Japanese cash to flood out of global markets and back home,” reported Garfield Reynolds of Bloomberg, The BOJ’s policy change wasn’t the only surprise last week. The U.S. economy also upended expectations as its growth accelerated in the second quarter. Gross domestic product (GDP), which is the value of all goods and services produced in the U.S., grew by 2.4 percent from April through June. That was well above both first quarter growth (2.0 percent) and economists’ expectations for second quarter growth (1.5 percent), reported Angela Palumbo of Barron’s. Economists who thought the July rate hike might be the Fed’s rate-hiking-cycle finale headed back to their spreadsheets to reassess the data. Last week, major U.S. stock indices finished higher, reported Barron’s. Yields on short U.S. Treasuries finished the week above 5 percent and most longer maturity Treasuries offered yields above 4 percent. The exception was the benchmark 10-year U.S. Treasury. |
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