End-of-Summer fade
SUMMARY
Following Mr Powell’s very hawkish comments at the Economic Symposium at the end of last week, several other Federal Reserve Board members and regional presidents jumped on the bandwagon this week to reinforce the Fed’s one-dimensional focus on aggressively curbing inflation. Each comment was another kick in the knee for risk markets, which continue to slowly hand back the gains that have accrued since mid-June following a poor first few months of 2022. The jobs market seems robust enough still in both the US and Eurozone, which is perhaps providing some cover for the Fed and ECB to continue to talk tough and to focus solely on bringing inflation back towards the 2%/annum target, even though this level feels so far away at the moment.
The hawkish comments are also pushing yields in government bonds higher, not only in the US, but increasingly in the UK and Eurozone. Changes in yields at the short end of the curve “guide” central banks if they get out of line (meaning if they are too slow to raise overnight bank rates to address inflation). However, what might be more concerning is that intermediate and longer maturity bond yields are also accelerating upwards again. One might interpret this two ways. On one hand, increasing long term yields signal that the likelihood of a recession is lessening. On the other hand, higher yields could indicate that inflation is becoming entrenched and will therefore take a longer period of time to address. Slowly, I am moving from the first camp to the second. Whatever the reason – and even though their economies are increasingly fragile – yields on government bonds in the UK and Eurozone are widening quickly, similar to bouts of yield increases we have seen from time to time in the US Treasury bond market for several months. Take a look at how yields have moved in just the last week and month in the UK, the Eurozone and the US.
As you can see in the table, the widening at the 2-year and 10-year maturities has been more severe in the UK and the Eurozone over the last week and month than in the US. Higher government bond yields are not the friend of stocks in such an environment and are one of several culprits currently contributing to weakness in equity markets in the US, the UK and the Eurozone.
Perhaps reflecting the lag in policy actions and the fact that central banks were late to react to persistent inflation in the first place, the jobs market has only been getting stronger even as central banks are trying to slow things down. Although Friday’s jobs report for August showed that US unemployment rose to 3.7% (from 3.5% in July), more jobs were added than expected for the month (albeit less than in July). In addition, the JOLTS report on Monday showed that the number of job openings remained about the same in August as in July (11 million). Even though the number of unemployed in the US rose to 6 million in August (+344 thousand), there are still nearly two jobs available in the US for every unemployed American.
In Europe, the situation is not dissimilar. Eurostat reported on Thursday that unemployment in the Eurozone and the EU for July decreased to 6.0% and 6.6%, respectively, well below pre-pandemic levels
and the lowest levels since before the GFC (and perhaps longer), as you can see in the graph to the right from the Eurostat report. To make things more complicated for the ECB, Eurozone flash CPI for August increased to 9.1%/annum (from 8.9% in July). It appears that neither the UK nor Eurozone have seen peak inflation, which the US might have already seen although upcoming data for August (to be released Sept 13th) will tell the real story. The combination of ongoing high inflation and tight labour markets is causing investors to increasingly tilt their expectations for central bank rate increases at policy meetings in September towards the higher end of expected ranges.
One final thing to keep in mind as UST yields head higher is that the Federal Reserve is doubling its balance sheet reduction starting this month, from $47.5 billion/month (June-August) to $95 billion/month (across US Treasuries and MBS). This will most certainly put further pressure on yields at the intermediate and long end of the UST curve.
I am trying to find some sliver of hope as far as equities and other risk assets, but it is increasingly difficult. All I can recommend is to be defensive if you are a long-term investor and prefer to be long, and to lighten into strength if you have trouble sleeping at night during bad runs, because I suspect we will have heightened volatility as markets drift lower in the weeks ahead.
MARKETS THIS WEEK
Investors have been raising concerns about the legitimacy of the recovery in risk assets since mid-June. Throughout August it was also becoming increasingly clear that central banks were trying to close the door on expectations for a potential near-term pivot. These two factors led to a reversal of fortune for equity and bond markets in mid-August, starting a slide that was reminiscent of the first half of the year. For example, the S&P 500 lost 23.1% YtD through June 16th, gained 17.4% from June 16th to August 16, and has now lost 8.8% since August 16th. Corporate credit has followed a similar pattern with credit spreads increasing, most perversely in high yield, since early August. Yields on US Treasuries bounced around for much of the summer before heading higher, with the 2-10 year yield curve inverting on July 6th and remaining inverted since then, even though the mixed jobs report on Friday brought some relief.
As we enter September – a notoriously difficult month for equities historically[1] – the outlook is murky at best. An attempted rally during the first half of Friday’s session faded badly in the afternoon, as both equity and corporate bond markets weakened sharply. Gold, oil and cryptocurrencies were all worse for the wear, too, joining global equity and bond markets as they spiral down. The UST market recovered Friday afternoon on the mixed US jobs report, but not enough to offset sharp losses for the week. One thing going the other direction is the US Dollar, which is breaching levels not seen in over 20 years. Sterling has slipped to $1.15/£1.00, a level I didn't think imaginable a few weeks ago, and the Euro is below Dollar parity. I suspect this could get worse for the Pound and Euro.
Below is a summary chart of how the indices and other assets I follow performed this week and YtD, with the full detail in the section “The Tables” further below.
ECONOMIC AND GEOPOLITICAL NEWS THAT MATTERED THIS WEEK
JOLTS report (US): The JOLTS (“Jobs Opening and Labor Turnover Survey”) for August was released on August 30th. The report showed no change in job openings in the U.S. for the month, which remained at 11 million.
August Jobs report (US): The BLS released the August jobs report on Friday before the market opened, showing a slight increase in unemployment for August to 3.7%. However, 315,000 jobs were added in the US in August, beating expectations albeit fewer new jobs than were added in July. I would consider the jobs report mixed, probably trending in the direction that the Fed was hoping. The August jobs report from the BLS is here.
Unemployment for July and flash CPI for August (EU): Eurostat released flash CPI for the Eurozone for August on Wednesday, which showed that inflation increased to 9.1%/annum (from 8.9% in July). Not surprisingly, the biggest contributor to European inflation was energy costs. Eurostat released the Europe jobs report for July the following day, which indicated that unemployment fell to 6.6% in the Eurozone and 6.0% in the EU in July.
WHAT’S NEXT?
Here are some of the key data and dates on which to focus.
Labor Day in the US on Monday September 5th – markets closed
Important data this coming week includes:
Eurozone retail sales on Mon
Various US PMI services data Tues
Japan 2Q22 GDP Thurs (Japan) (consensus 0.7% QoQ / 2.9% annualised)
Various Fed officials speaking throughout week including Chair J Powell (Cato Institute), Vice Chair L Brainard (Bank Policy Institute), and regional Fed presidents E George, T Barkin and L Mester
C Lagarde press conference following ECB policy meeting / rate decision on Thurs (see below)
Upcoming central bank meetings (current bank rate and expected increase at policy meeting is in brackets):
European Central Bank – September 8th (0% now, consensus +0.50% – 0.75%)
Bank of England – September 15th (1.75% now, consensus +0.50%)
Federal Reserve – September 20th-21st (2.25%-2.50% now, consensus +0.50% – 0.75%)
THE TABLES
Global equities
US equities
US Treasuries
Corporate bonds (credit)
Safe haven and other assets
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[1] Although dated, a 2019 report from Stock Analysis (here) provided monthly returns for the S&P 500 from 1980 to 2018, showing that September had been one of only two months during that period in which the average return on the index was negative (– 0.70%). For reference, the other negative month was August (–0.15%).
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