Week ended June 2, 2023
Off we go again!
The sorting of the debt ceiling crisis in the US and a sufficiently ambiguous series of economic data releases involving the US jobs market were a tasty combination that drew risk investors back into the equity markets with a vengeance towards the second half of a holiday-shortened week. Global equities also benefited more broadly from a risk-on shift in sentiment. Importantly perhaps, this run – during which the S&P 500 touched its highest level since August 18th 2022 – was more broadly based in that the laggard indices like the more concentrated (and some might say “boring”) DJIA and the value-skewed Russell 2000 also chalked up nice weekly gains for a change. In fact, the much-maligned Russell 2000 was the best performer amongst Stateside equity indices for the week, and it has been a long time since that occurred. The week wasn’t all about the giant tech names, although they did fairly well too as you can see below.
Internationally, European equities were mixed, with the FTSE 100 once again leading the race to the bottom as far as May and YtD returns. Japanese equities continue their torrid run thanks to an accommodative Bank of Japan, and even Chinese / emerging markets equities showed some life this week. Ah, life is good again, and we have the “all clear” or so it seems. In fact, May was more or less flattish in equities and slightly lower in bonds, especially at the shorter end of the curve that is more influenced by Fed rate expectations. This was remarkable given the wild gyrations in Fed policy expectations and the debt ceiling debacle that occurred throughout most of the month, and I am shocked it was not significantly worse. The fact is that if you look closely enough, you can find plenty of signs of weakness in the US and global economies that are concerning. Nonetheless, the fact remains that the jobs market in G7 countries (driven particularly by strength in the US jobs market) remains relatively resilient, complicating the tasks of central banks as far as addressing sticky core inflation. Enough of that over-thinking for now because it might ruin the feel-good of the late-week rally as we head “to the moon.”. Let me end my rant this week by warning of potential distortions in the UST yield curve as the Treasury reloads on liquidity by issuing new bonds once the debt ceiling agreement is signed, sealed and delivered. There has been plenty of speculation around this, now coming to the forefront. I can offer no insights other than what the mainstream financial press has covered, aside from the fact that this would seem logical to me. It will be interesting to see the effect of the Treasury’s unusually large issuance of USTs on yields across the curve and how long any potential distortions might last.
WHAT HAPPENED THIS WEEK THAT MATTERED
Debt ceiling deal: The debt ceiling bipartisan “compromise” deal has now passed both the House and the Senate and will shortly be signed by President Biden. What a drama and distraction to what really matters in markets going forward, but welcome to US politics! Although a US debt default was avoided, the damage might linger. The most amazing thing to me was the US Dollar strengthened during this politically charged nightmare, proving that predicting market directions across any asset class is a losers’ game.
Fed’s next move: It appears to me after wild swings in “will the Fed / won’t the Fed” raise the Fed Funds rate another 25bps at the mid-June FOMC meeting, we are now staring at a potential skip. You have to love the terminology! Indeed, a “skip” is a way of signalling that the Fed might pause (more terminology) in June to better understand the direction of the US economy before potentially raising rates at the subsequent FOMC meeting in July. It was always the case that as soon as the debt ceiling crisis passed, attention would turn somewhere else. With earnings now past, the logical target was Fed guesstimating. If economic data isn’t enough, the Fed rolled out its talking heads in the past week to “signal” direction. Although skewed towards an upcoming (and potential one-off) pause, the “Fed Speak” was not consistent, suggesting division amongst Fed officials as to the next rates move. You might believe that the short end of the UST curve provides the best guidance, although gyrations in the yield of the 2y UST have been wide and rather volatile since the beginning of May. Even so, the yield on the 2y UST ended May 36bps wider than at the beginning of the month. The CME FedWatch tool, also generally believed to be a decent indicator of the next Fed rates decision, has moved all over the place too, just in the past week in fact. Currently, it is indicating a 75% probability that the Fed pauses on June 14th, and a 25% probability it increases the Fed Funds rate by 25bps. We have had mixed jobs data over the last week, but the US labour market continues to be resilient. If I had to place a bet now though, I would be overly influenced by FedSpeak, and do believe that the Fed might pause in June but leave the door open for future rate hikes if needed. We do have a critical data read ahead of the next FOMC meeting, which is May CPI (to be released on June 13th).
US jobs: Not much to add to what you have read on this, aside from the obvious – the US jobs market remains much more robust that the Fed would like given that core inflation remains sticky. Unemployment ticked up in May, but new jobs massively exceeded expectations (BLS jobs report for May here). To boot, the recent JOLTS data indicates that there are over 10 million jobs to be filled in the US, with “only” six million unemployed people. That does not scream a slowing labour market to me.
Corporate bonds (credit)
Safe haven and other assets