Updates

Attention shifting to employment data…

• Markets continue their shift in focus away from inflation data points and towards the jobs data. Last Friday, the Labor Department released its August jobs report and Wall Street was not impressed. The popular S&P 500 index closed down 1.7% and ended the week with its largest weekly loss in 18 months. The labor report showed 142,000 jobs being added in August – far below the recent monthly average of 173,000 jobs. Meanwhile, the August unemployment rate, measured at 4.2%, maintaining its relatively elevated levels.

• There are growing fears if the job data continues its recent negative trend that the economy will sail past a possible soft landing and enter into recession. Central bankers will begin meeting next week to debate on the size of their first rate cut, either a 0.25 percentage point reduction or a larger 0.50 percentage point rate cut. Two weeks ago, the odds were evenly split between a large and a small rate cut. Today, forecasts sharply favor a more modest 0.25 percentage point cut. Only the first of a series of anticipated rate cuts, next week’s reduction is predicted to be the first step of an anticipated total 2.5 percentage point decline in overnight rates over the next 18 months.

• Supporting this position was Wednesday’s Consumer Price Index (CPI) report which showed inflation coming in slightly below expectations. The reading, at 2.5%, was modestly better than the predicted 2.6% increase in prices. While not yet at the Federal Reserve’s target of 2.0%, this report highlighted inflation’s ongoing decline and re-affirmed the belief that a Fed rate cut next week is an absolute certainty. The less important Producers Price Index (PPI), an inflation report based on the supply chain, report was released this morning and showed a 0.2% increase relative to a consensus forecast of 0.1%of 1.8%-2.0%. Markets have paid little heed to this report, considering it a less important outlier.

• Taking a quick look at the political situation, former President Trump and Vice President Kamala participated in their first debate earlier this week. Going into the debate, polls were largely a dead heat between the two presidential candidates. After the debate, the perception has largely been that Vice President Harris won although the two major predictive models still suggest that the election is a tossup. Expectations are high for a proposed additional debate between the two candidates.

Times, they are a changing…

• As Fed Chair Powell announced that “the time has come for policy to adjust” at his Jackson Hole speech last Friday. Of all of Powell’s recent public statements, this is the first time he has clearly and definitively communicated the central bank’s intention to start cutting the overnight Federal Funds rate. The question now is how much will the Fed cut and how frequently? The next Fed meeting is in three weeks, current forecast predicts a 70% chance of a 0.25 percentage point rate cut and a 30% chance of 0.50 percentage point rate cut.  Before year-end, predictions are for a 76% likelihood of a 1 percentage point reduction in the overnight interest rate.  In any scenario, we believe a larger initial rate cut would be unwarranted as it would likely spook the financial markets.

• When the Fed does begin cutting the overnight borrowing rate, it will have a significant impact across the fixed income markets. Rates that affect the average consumer such as credit card debt and home equity lines of credit should all be impacted. Most importantly, mortgage rates, which are largely priced upon the 10-Year US Treasury rate, should continue their recent drop as rate expectations have moderated over the last several weeks.

• This Friday the Fed’s preferred inflation gauge, the Personal Consumption Expenditures Price Index (PCE), for July will be released. The market is largely expecting this reading to continue its recent downward trend towards the Fed’s target goal of 2%. For the vast majority of this interest rate cycle, the PCE report has been the most watched report as the Fed placed increasing focus on reeling in inflation. At this point, the battle against inflation appears to largely be won. The Fed now is turning its attention to the labor market that has seen the unemployment rate recently increase to 4.3%, up markedly from last July’s 3.5% reading.

• Not helping the Fed newfound labor market attention was the Labor Department’s report last Wednesday which had surprising downward revision of 818,000 jobs created over the twelve months prior to March. Instead of adding on average 246,000 jobs a month, the U.S. economy added only 178,000 a month, or 28% fewer positions than had originally been believed. While economists had expected a downward revision, the revisions magnitude was unexpectedly large. Interestingly enough, the market took this news in stride and ended the day in the green.

A tumultuous stretch as the markets eagerly look towards an initial rate cut…

• In early August, the broader stock market collapsed almost 7% in a matter of days on the back of July’s weak jobs report and the unwinding of the yen “carry trade.” Non-farm payrolls came in sharply beneath expectations at 114k as opposed to the forecast of 190K. Additionally, the U.S.’s unemployment climbed to 4.3%, and above the market’s expectations. Exacerbating the issue was trader’s efforts to unwind previously cheap borrowings in Japan as the yen climbed sharply relative to the US dollar following an unexpected rate increase by the Bank of Japan.

• In subsequent days, the market largely recovered these recent losses as concerns over economic growth abated. Correspondingly, the market’s volatility index, which had soared by more than 100% amidst the market’s sharp decline, slid back to prior levels in subsequent days as the market recovered most of its losses.

• Based on the most recent data, expectations are strongly fixed upon a central bank rate cut following their September meeting.  Today’s Consumer Price Index release showed continued cooling with a 2.9% overall year-over-year price increase for July -providing further support to the thesis that inflation is sufficiently moderating and keeping the Federal Reserve teed up for an initial interest rate cut in September. Beating expectations of 3% and printing a sub 3% annual rate for the first time since March 2021, the data release provides evidence that the fight against inflation is succeeding.

• However, in an attempt to dampen expectations, recent comments from Fed leadership have echoed Chair Powell’s prior messaging that the Federal Reserve will remain data dependent on potential rate cuts and, therefore, that a September rate cut is not yet assured. Conversely, there are increasing fears that the central bank’s reluctance to cut rates may already have set the economy on an inescapable path to recession.

Will it soon be time to take action?

• Today is Fed Day, the day that the Federal Open Market Committee (FOMC) releases its update on its interest rate outlook. Earlier this afternoon, officials moved closer to lowering interest rates from their two-decade high by signaling the likelihood of a September rate cut.  The US central bank’s Federal Open Market kept its benchmark rate in a range of 5.25% to 5.5%, a peak reached a year ago, at the conclusion of its two-day policy meeting. Policymakers acknowledged that inflation has made progress toward their 2% goal — a prerequisite for rate cuts — following tame readings on consumer prices for the month of June. With unemployment also edging higher, officials indicated it’s appropriate for policy to become less tight soon. However, even if there is a September rate cut, it does not mean that other actions will immediately follow suit.

• As for the markets, the Mega Cap tech stocks have had a tumultuous month having sustained losses in excess of $1.5 trillion before recovering in recent days. Alphabet, the parent company of Google and YouTube, reported a slowing of sales while Tesla announced that its profitability took a hit due to a reduction of revenue as well. Microsoft meanwhile has modestly sold off today as it reported a massive increase in capital outlays. However, a positive outlook from chip stock Advanced Micro Devices (AMD) has spurred a broad tech rally with Nvidia rising by almost 12% today and dragging along most tech players with it. Notwithstanding AMD’s upbeat outlook, reported results in the tech sector have largely been beneath expectations.

• Recent readings on the job openings came in above forecast last month with also May’s reading being revised higher – defying the recent softening in the labor market. Available positions, known as JOLTS, edged lower to 8.18 million on Tuesday, exceeding most estimates. The reports showed that solid demand remains for workers even as unemployment rose for a third straight month in June. Meanwhile, the number of vacancies per unemployed worker, a closely watched ratio by the Fed, held steady at 1.2 – and in line with levels seen prior to the pandemic. However, appreciable concerns have arisen regarding the accuracy of the JOLTS and vacancies per worker data as response rates to the government surveys have declined severely over the last several years.

• On the political front, uncertainty remains with the presidential election less than 100 days away. The week after Trump’s assassination attempt, it appeared as though former President Trump was on his way to a landslide victory. However, with President Biden dropping out of the race and Vice President Harris stepping in, the Democratic party has fervently gathered behind the current VP. Most polling now shows the race to be a dead heat. It is unclear whether this polling bounce is just a honeymoon period for Harris and the Democrats or whether it will be sustained. For the time being, substantial uncertainty exists regarding the likely outcome of the Fall elections.

No recent love for the Magnificent Seven…

• Following the horrific assassination attempt on a former President, polling data is now strongly predicting a second Trump Administration. Meanwhile, President Biden is facing continued pressure to step down from the Democratic ticket for the upcoming election. Markets have been digesting the forecast of another Trump presidency by determining how to be positioned and act towards the now anticipated high tariff and more inflationary environment that is likely to result.

• In the meantime, current inflation readings continue to abate as seen by the recent Consumer Price Index (CPI), a figure released last week.  June’s CPI declined with a 12-month rate of 3.0%, the lowest annual increase in three years whereas the Producer Price Index (PPI) reading was less positive with a 12-month rate increase of 2.6% – the largest annual increase since March of 2023. However, the U.S. consumer continues to spend though as retail sales remained flat year-over-year as opposed to expectations of a decline.

• Meanwhile, Fed Chair Powell made a major public appearance at the Economic Club of Washington on Monday. Despite recent inflation data continuing to trend lower, Powell’s public was unchanged with him stating that “I’m not going to be sending any signals one way or the other on any particular meetings.” Further, Chair Powell expressed his belief that the economy is heading for an economic soft-landing and that a “hard landing” did not seem likely at this point.

• The equity markets have had an appreciable rotation in recent days with mega-cap tech stocks experiencing recent declines. Surging forward have been small cap stocks with five days of consecutive gains and a 3.5% gain on Tuesday.  This is however a positive sign that the stock market rally is broadening to other parts of the market and showing investors’ confidence in the American economy.

Still waiting for the Fed as the presidential election heats up…

• On Tuesday, Fed Chair Jerome Powell released statements that sounded more dovish than other recent comments. Powell stated that the Federal Reserve has seen “a lot of progress” in relation to inflation, but that policymakers need more data before cutting interest rates to verify that recent weaker inflation readings are providing an accurate picture of the economy. After Chair Powell refused to set a prospective date for the first rate cut, analysts are now banking upon an initial rate cut to occur by early November.

• Likely influencing the central banker’s comments was Friday’s personal consumption expenditures (PCE) price index release. The Fed’s preferred inflation reading showed a 2.6% year-over-year increase with no change from April for the month-over-month reading. Core PCE showed a 0.1% monthly increase, and 2.7% year-over-year increase. While still above the U.S. central bank’s 2.0% target, the PCE reading is on its way down after a scare in the first months of the year.

• Additionally, Tuesday’s Job Opening and Labor Turnover Survey (JOLTS) Report showed 8.14 million openings vs the 7.946 million estimated. While the May JOLTS quit rate remained unchanged at 2.2%, it is near pre-pandemic levels and suggests that wage inflation continues to moderate. The reading provides insight into the United States labor market and could be a data point encouraging the Federal Reserve to entertain cutting rates sooner.

• Following a weak performance by President Biden in the year’s first electoral debate with former President Trump, many investors now believe the odds of a new Trump presidency have increased. Markets are still trying to absorb this potential outcome and ascertain what this presidency could mean for the capital markets.

Still trying to figure out inflation……….and the Fed

• Based on the CME Fedwatch tool, bond traders are no longer predicting that the Fed will cut interest rates by more than 75 basis points this year – their view finally now moving in line with what has been the central bank’s projected likeliest outcome for months. To this end, the benchmark U.S. 10-year Treasury has hovered in a tight range between 4.25% and 4.33% in recent day.
• With the focus remaining on the Fed, investors have been bracing for tomorrow’s critical inflation release which is likely to strongly affect the Fed’s mid-March meeting. The Thursday release of the Personal Consumption Expenditures (PCE) prices report is eagerly awaited on Wall Street after data earlier this month called price growth progress into question. Investors have already backtracked dramatically from previous hopes for rate cuts starting in March, and a disappointing PCE report could further reinforce “higher for longer” concerns regarding Treasury yields.
• Additionally, the wave of consumer optimism finally broke this month as the Conference Board’s consumer confidence index fell for the first time since November. Labor market uncertainty as well as the coming election, though not inflation, poured cold water on the survey, which was expected to show confidence having held steady at a two-year high.
• On the global stage at this week’s G-20 meeting, Treasury Secretary Janet Yellen cited central bank interest-rate hikes around the world as one potential risk to a generally favorable economic outlook. She also noted that “inflation has been coming down in many countries,” while stopping short of suggesting that rate cuts might now be appropriate. Geopolitical risks pose another danger, with “significant economic spillovers” in the case of an expanded regional conflict in the Middle East, Yellen said.
• On a more positive note, the likelihood of yet another federal government shutdown this weekend appears to be fading. Congressional leaders expressed confidence yesterday that they could avoid a partial government shutdown on March 1 after meeting at the White House with President Joe Biden. We hope that this optimism is warranted as the repeated government shutdown ill serves members of all political parties.

Cautionary inflation and consumer readings spread concerns…

• Following the long weekend, investors returned today staring down earnings from the nation’s biggest retailers and an update on the Federal Reserve’s rate path perspective. Additionally, market star Nvidia (NVDA) shares its latest results on Wednesday afternoon. Last week, however, did close on a down note – ending a five-week winning streak on Wall Street.

• Driving the decline were U.S. consumer and wholesale inflation readings which helped put the rally genie back in the bottle. Wholesale prices in the United States picked up in January, the latest sign that some inflation pressures in the economy remain elevated. The Labor Department reported Friday that its producer price index — which tracks inflation before it reaches consumers — rose 0.3% from December to January after having fallen -0.1% from November to December.

• Additionally, the January retail sales report showed sales dropped. The whole sale price reading provided the latest sign that some inflation pressures in the economy remain elevated. In other words, neither inflation nor consumer spending readings showed improvement. To date though, markets seem largely impervious to suggestions that the Federal Reserve isn’t going to start cutting interest rates any time soon. The good news for stocks has been surprisingly strong economic growth and low unemployment. At some point, though, the sharp Fed rate hikes since 2022 will start to bite into corporate performance. Compounding the issue, consumers have run down savings from the Covid-19 pandemic and mortgage rates are once again climbing to two-decade highs.

• Additional messaging from the central bank will happen on Wednesday when minutes from the last Fed rate setting meeting are released along with at least five central bankers giving speeches later in the week. Current messaging suggests that the Fed is in no rush to start cutting rates. Expectations for the first move lower have now slid back to June. It should be kept in mind that as recently as a few weeks ago, rate cuts were anticipated as early as this March, at least according to the CME FedWatch tool. The markets are finally starting to pay attention, even if not embracing, the central bank’s continued signaling of “higher for longer” – even if the broader ramifications of this policy remain in doubt.

• Following the Fed’s most recent meeting, the equity markets have continued to rally despite additional commentary from the central bankers emphasizing that rate cuts are very unlikely to start in March. Over the weekend, Chair Powell, in an interview on the TV show 60 Minutes, said that he is “pleased inflation is coming down quickly and the economy is strong.”  However, the takeaway from his commentary was that the Fed can afford to be patient when deciding when to start lowering interest rates. It was the very same message he gave at last week’s interest-rate decision, and he also reiterated that the Fed only sees three quarter-point rate cuts this year, whereas the market still predicts as many as six.
• An unexpectedly robust jobs number on Friday underlined the point that the economy does not need any help from the Fed to keep humming with unemployment of 3.7% and the 4^th quarter’s GDP growth of 3.3%. While officials are growing more confident that inflation is heading toward their 2% target, Fed policymakers are unlikely to have the necessary confidence to cut rates by the March meeting, seven weeks from now.
• Adding a counterpoint of market support in the face of renewed emphasis on rates being higher for longer, the corporate earnings season has turned more positive. With more than half of the S&P 500 having reported earnings, annualized earnings growth of 1.6% is now anticipated for the fourth quarter, according to FactSet. If corporate earnings remain positive, it will represent a second-consecutive quarter of earnings growth.
• As for international affairs, markets seem to have quietly accepted the ongoing war in Ukraine, the Israeli invasion of Gaza, and the escalating Houthi attacks on Red Sea shipping. At least until they don’t. With the market’s fear gauge remaining near multi-year lows, there is much investor complacency in the face of these potential international flash points.

• After drifting up the last few days of 2023, Wall Street starts the New Year a bit nervous with broad declines in many securities, especially in those sectors which have recently outperformed. One Schwab analyst suggested that the recent declines broadly reflected a combination of profit-taking and investor rotation into last year’s underperforming sectors, specifically energy, health care, and utilities. Adding to recent downward pressure, concerns about increased tensions in the Middle East have caused global oil prices to rise. Also of continued worry is the ongoing U.S. standoff with China over semiconductors as the Netherland government ordered a major chipmaker equipment supplier to suspend some exports to China.

• As the week progresses, investors will be focused on new economic readings as they should give additional color to the Fed’s next move. Nonfarm payrolls, unemployment, and job openings data are all coming out over the next several days with expectations remaining generally positive. Counterbalancing some of the recent optimism was today’s job openings data which hit two-year lows – thereby fueling concerns that the labor market may be softening faster than the Fed originally predicted.

• Currently, five or six quarter-point Fed interest rate cuts are projected for 2024. By contrast, a December forecast by the Fed suggested that the central bank would only make three cuts. As of this morning, the CME Fedwatch Tool was predicting only a modest likelihood of a rate change at the FOMC’s January end meeting but a nearly 72% likelihood of a rate cut at the Fed’s March meeting.

• The challenge for investors currently is that stocks appear to be priced for perfection while there is still much that could go wrong. There is a reasonable likelihood that inflation is more sticky and that the Fed does not cut as much as the market expects. If the Fed does loosen policy as much as anticipated, it may be because the economy has sharply slowed with production plunging as it runs into the wall of past rate hikes.