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Fed funds futures traders continued to boost their expectations for no further rate hikes by the Federal Reserve this year, after Wednesday’s data on private-sector payrolls and revised second-quarter GDP. The chance of no action by the Fed in September was seen at 90.5%, up from 86% a day ago, according to the CME Fed Watch Tool. Traders see a 57% and 55.5% likelihood of no action respectively in November or December, which would leave the fed funds rate at between 5.25%-5.5%.
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The numbers: The index of U.S. consumer confidence dipped to 106.1 in August from a revised 114 in the prior month, the Conference Board said Tuesday.
Economists polled by The Wall Street Journal had forecast a modest pullback to 116 from the initial reading of 117, which was the highest level in two years.
The revised July reading was the highest since December 2021.
Key details: Part of the survey that tracks how consumers feel about current economic conditions fell to 114.8 this month from 153 in July.
A gauge that assesses what Americans expect over the next six months dropped to 80.2 from 88. The August reading is just above to 80 level that historically signals a recession within the next year.
Big picture: The tight labor market had bolstered confidence in June and July. The decline in August reverses all of those gains. The index is still 10.8 points above the recent cycle low in July 2022.
Economists think that higher gasoline prices were behind some of the decline in August. The price of a gallon of unleaded gasoline is up 19.6% from the start of the year and over 2% from last month.
What the Conference Board said: The organization said it still expects a recession before the end of the year.
“Write-in responses showed that consumers were once again preoccupied with rising prices in general, and for groceries and gasoline in particular,” said Dana Peterson, chief economist at The Conference Board.
What are they saying? “The August drop does not definitively end the upward trend in place since last summer, and the expectations index still points to faster growth in real consumption spending. We are not convinced, however, in part because some of the strength in July retail sales was due to boost from Amazon Prime Day, which won’t continue, and because near-real-time indicators of discretionary services spending paint a much less upbeat picture,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics.
Robert Frick, corporate economist with Navy Federal Credit Union, said he didn’t think confidence would rise significantly until inflation falls further.
Market reaction: Stocks
DJIA
SPX
were trading higher on Tuesday. The yield on the 10-year Treasury note
BX:TMUBMUSD10Y
fell to 4.16%.
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U.S. stocks scored back-to-back gains on Monday in an attempt to claw back ground in a rough August for equities. The Dow Jones Industrial Average
DJIA,
rose about 213 points, or 0.6%, ending near 34,560, according to preliminary data from FactSet. The S&P 500 index
SPX,
closed 0.6% higher and the Nasdaq Composite Index
COMP,
gained 0.8%. Investors kicked of the final week of August on an upbeat note, while largely focusing on Thursday’s inflation data and Friday’s monthly jobs report to help inform the Federal Reserve’s path on interest rates and its inflation fight. The 10-year Treasury yield
TMUBMUSD10Y,
eased back to about 4.20% late Monday after its sharp rise a week ago to its highest level since 2007. The Dow still was off about 2.8% so far in August, while the S&P 500 index was 3.4% lower and the Nasdaq was down 4.5%, according to FactSet.
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Investors sitting on the sidelines in cash and in money-market funds might consider moving into longer-dated bonds sooner rather than later, according to Saira Malik, chief investment officer at Nuveen.
As look at historical returns shows the broader $55 trillion U.S. bond market typically outperforms short-term Treasurys at the end of past Federal Reserve rate hiking cycles since the 1990s.
The bond market produced an average 5.5% three-month rolling return following the last rate hike (see chart) in the past four Fed hiking cycles, while short-term Treasurys returned 2.1%.
Bloomberg, Nuveen
Of note, the magnitude of the bond market’s outperformance faded by 12 months versus short-term positions, when looking at the Bloomberg U.S. Aggregate Bond Index’s performance relative to the Bloomberg U.S. Treasury 1-3 Year Index.
“The broad market typically experienced a strong relief rally immediately after the Fed pause and mostly outperformed the following year,” Malik said, in a Monday client note. “This lends further credence to our view that overallocating to cash or short-term government debt could be a mistake — and that investors may want to start closing their duration underweights.”
Individuals can gain exposure to Wall Street bond indexes through related exchange-traded funds, including the iShares Core U.S. Aggregate Bond ETF
AGG
and the SPDR Bloomberg 1-3 Year U.S. Treasury Bond UCITS ETF
UK:TSY3
for short-term Treasury exposure.
Fed Chairman Jerome Powell signaled on Friday that additional rate hikes might be needed to keep the U.S. cost of living in retreat, even though rates already sit at a 22-year high and inflation has fallen sharply in the past year, while speaking at the annual Jackson Hole gathering in Wyoming. He also reiterated a vow to keep rates at a restrictive level for a while to keep inflation in check.
Malik pointed to cooling housing inflation as a positive sign on the inflation front. Home buyers have pulling back as the benchmark 30-year mortgage rate hit an average of 7.31%, the highest levels since 2000.
She also expects U.S. economic growth to slow and a “partial retracing” of the 10-year Treasury yield
BX:TMUBMUSD10Y,
following its surge in recent weeks.
“Historically, the 10-year yield has peaked within the last few months of the final rate hike in a tightening cycle. We expect this hike will occur at either the September or November Fed meeting, and that the 10-year yield will decline through year-end.” Yields and debt prices move opposite each other.
Related: Pimco emerges as a buyer in Treasury market selloff, says Bond Vigilante theme ‘a bit extreme’
Stocks were higher Monday, with the Dow Jones Industrial Average
DJIA
up 0.5%, the S&P 500 index
SPX
0.3% higher and the Nasdaq Composite Index
COMP
up 0.4%, according to FactSet.
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The U.S. dollar is proving its haters wrong.
Not only is the buck defying the expectations of Wall Street strategists who had anticipated that it would weaken this year, it’s also proving once again that talk of de-dollarization has been over-hyped.
In financial markets, a gauge of the dollar’s value against its biggest rivals is nearing its highest level in six months. The ICE U.S. Dollar Index
DXY,
a gauge of the dollar’s strength against the euro
EURUSD,
and other major currencies like the Japanese yen
USDJPY,
and British pound
GBPUSD,
traded at its highest level since early June on Friday after Federal Reserve Chairman Jerome Powell helped catapult it higher by talking up the possibility of more interest-rate hikes.
The index was adding to those gains on Monday, trading 0.1% higher at 104.13, according to FactSet data. A break above 104.70 would put it at its highest intraday level since March 16. The index is up 0.5% since the start of the year, having erased earlier year-to-date losses over the past six weeks.
Earlier this year, dollar weakness occurred against the backdrop of U.S. rivals like China and Russia making strides in their efforts to wean themselves off the buck.
But despite their efforts, data released last week by SWIFT, the nexus of international interbank financial transactions, showed that the dollar has never been more popular as a means of settling international trade and transactions.
SWIFT’s data showed that 46% of interbank payments conducted on the platform in July involved the U.S. dollar, a record high. The data also showed that the Chinese yuan’s share of international payments had ticked higher while the euro’s declined.
As if to underscore this point, the data from SWIFT arrived late last week just as a summit hosted by the BRICS nations in Johannesburg, South Africa, was breaking up.
Rather than being a watershed event for opponents of the U.S. dollar, as some had feared, statements from the group’s members revealed internal disagreement on the subject of a BRICS currency intended to offer an alternative to the greenback.
What’s more, while the economic alliance announced plans to admit a spate of new member nations in its first expansion in 13 years, one notable holdout seemed to spoil the party.
Indonesian President Joko Widodo opted to keep his country, one of the world’s most populous, with a fast-expanding economy, out of the economic alliance, at least for now.
To be sure, as MarketWatch reported back in April, talk of de-dollarization is hardly a new phenomenon, but it has received renewed attention as China, Russia and others have redoubled efforts to try and push for countries to conduct more trade in their own currencies as opposed to the dollar.
But Russia and China aren’t alone in their disappointment at the dollar’s resilience.
Read more: Opinion: China is nowhere near deflation, and global investors aren’t ready for what’s coming
A compilation of 2023 year-ahead outlooks produced by Bloomberg News back in December showed investment houses in Europe and the U.S. widely expected the buck to weaken this year, with some reasoning that the two-decade high reached by the dollar index in late September likely marked its peak for the cycle.
The ICE index traded as high as 114.78 on Sept. 28, its highest level since May 2002, according to FactSet data. The milestone marked the peak of a torrid rally that saw the buck emerge as one of the few havens from a punishing selloff in stocks and bonds that defined global markets in 2022. But the gauge has fallen 9.3% since then.
Now, with real yields in the U.S. pushing higher and Federal Reserve Chairman Jerome Powell hinting at the possibility of more interest-rate hikes later this year, strategists say the conditions are ideal for the U.S. dollar to climb even higher.
“Interest-rate differentials and relative economic strength are the foundation [of dollar strength],” Matt Miskin, co-chief investment strategist for John Hancock Investment Management, said during a phone interview with MarketWatch.
China’s struggles to revive its flagging economy have helped bolster the dollar while pushing the Chinese yuan
USDCNY,
toward its weakest level since late last year. The offshore yuan traded at 7.29 to the dollar on Monday, near its weakest level since November.
Read this next: Opinion: The debt supercycle that hit the U.S. and Europe has now come for China
A weakening eurozone economy has weighed on the euro and boosted the dollar. PMI survey data released earlier this month showed Europe’s services sector weakening alongside manufacturing. GDP data released by Eurostat, Europe’s official economic statistics agency, has been tepid compared to the U.S. The latest reading on second-quarter GDP put it at 0.3%.
Right now, the dollar will be tough to beat given the twin tailwinds created by rising real interest rates and still-robust economic growth.
The yield on the 10-year Treasury Inflation-Protected Security note
912828B253
was trading north of 2.2% Friday, according to data from the St. Louis Fed. The 10-year TIPS yield hit its highest level since 2009 earlier this month when it broke north of 2%. The inflation-protected security is often cited as a proxy for U.S. “real” yields, which refers to the return bond investors receive after adjusting for inflation.
On the growth side of the equation, the Atlanta Fed’s GDPNow forecast estimated the rate of growth for the third quarter at 5.9% according to its latest reading dated Thursday. A year ago, even the most optimistic economists on Wall Street were expecting growth of about 2%, and top Fed officials had a median projection of 1.2% growth for 2023, according to projections released in September.
“It’s hard to beat the dollar when it is a high yielder among safe havens in a risk-off environment,” Steve Englander, head of North America macro strategy at Standard Chartered, said in comments emailed to MarketWatch.
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Federal Reserve Chair Jerome Powell set a high bar for additional interest-rate hikes, economists said Sunday in their commentary on all the talk at the U.S. central bank’s summer retreat in Jackson Hole, Wyo.
Michael Feroli, chief U.S. economist for JPMorgan Chase, said that the Fed chair certainly did not give a clear signal that more tightening was coming soon. He noted that Powell stressed the Fed would “proceed carefully” and balance the risks of tightening too much or too little.
“We remain comfortable in our view that the FOMC will stay on hold for the next several meetings,” Feroli said.
Read: Powell unsure of need to raise interest rates further
The caveat to this forecast is if inflation surprises to the upside or the labor market does not continue to soften.
Ian Shepherdson, chief economist at Pantheon, said that Powell’s speech seemed hawkish to some, particularly because the Fed chair made threats to hike again.
But Shepherdson said he thought the Fed “is likely done.”
“Behind the caveats, Mr. Powell’s speech fundamentally was optimistic, though cautious,” Shepherdson said.
Boston Fed President Susan Collins also emphasized patience in an interview with MarketWatch on the sidelines of the Jackson Hole summit.
Read: Fed has earned the right to take its time, Collins says
Other regional Fed officials who spoke “hinted that further action may be needed, but also observed that inflation is moving in the right direction and that the surge in yields would help cool down the economy,” said Krishna Guha, vice chairman of Evercore ISI, in a note to clients.
Traders in derivative markets expect a rate hike in November, but it is a close call, with the odds just above 50%.
The Monday following Jackson Hole has historically been an active one in the markets, across asset classes.
The 10-year Treasury yield
BX:TMUBMUSD10Y
ended last week just above 4.2%.
Read: Market Snapshot on Powell’s stance
The first test of the careful and patient Fed will come this coming Friday, when the government will release the August employment report.
Economists surveyed by the Wall Street Journal expect the U.S. economy added 165,000 jobs in the month. That would be the weakest job growth since December 2020.
In his speech on Friday, Powell emphasized that evidence that the labor market was not softening could “call for a monetary policy response.”
Economists at Deutsche Bank think an upside surprise in the employment data could provide enough discomfort for the Fed, and raise expectations for further tightening.
Other top global central bankers spoke at Jackson Hole, including European Central Bank President Christine Lagarde, Bank of Japan Gov. Kazuo Ueda and Bank of England Deputy Governor Ben Broadbent.
Guha of Evercore said he detected a careful effort by the officials not to surprise markets.
The exception to this rule might have been Bundesbank President Joachim Nagel, who said in a television interview that it was too early for the ECB to think about a rate-hike pause.
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The numbers: A survey of consumer sentiment hung close a two-year high in August, but Americans expressed more worries about the future of the economy.
The final reading of the sentiment survey in August slipped to 69.5 from a preliminary 71.2, the University of Michigan said Friday. The index hit a 22-month high in July.
The consumer-sentiment survey reveals how consumers feel about their own finances as well as the broader economy.
Key details: A gauge that measures what consumers think about the current state of the economy registered 75.7 at the end of August vs. an initial 77.4
A measure that asks about expectations for the next six months dropped to 65.5 from an initial 67.3 in early August and 68.3 in July.
Americans think inflation will average 3.5% in the next year, a few ticks higher compared to several months ago.
The official rate of inflation is 3.2%, using the consumer price index, though other measures suggest prices are rising somewhat faster.
Big picture: Steady economic growth, ultra-low unemployment and slowing inflation have made Americans less worried about a recession.
Yet interest rates are high and likely to remain so through next year as the Federal Reserve aims return the inflation genie to the bottle. Higher borrowing costs are all but certain to depress the economy and perhaps increase unemployment
Looking ahead: “Consumers perceive that the rapid improvements in the economy from the past three months have moderated, particularly with inflation, and they are tentative about the outlook ahead,” said Joanne Hsu, director of the survey.
Market reaction: The Dow Jones Industrial Average
DJIA,
and S&P 500
SPX,
rose in Friday trades.
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U.S. mortgage rates increased for the fifth week in a row, with the 30-year reaching the highest level since 2001.
The 30-year fixed-rate mortgage averaged 7.23% as of Aug 24, according to data released by Freddie Mac
FMCC,
on Thursday.
It’s up 14 basis points from the previous week — one basis point is equal to one hundredth of a percentage point.
The last time rates were this high was in June 2001.
A year ago, the 30-year was averaging at 5.55%.
The average rate on the 15-year mortgage rose to 6.55% from 6.46% last week. The 15-year was at 4.85% a year ago.
Freddie Mac’s weekly report on mortgage rates is based on thousands of applications received from lenders across the country that are submitted to Freddie Mac when a borrower applies for a mortgage.
Separate data by Mortgage News Daily said that the 30-year fixed-rate mortgage was averaging at 7.36% as of Thursday afternoon.
What Freddie Mac said: “Indications of ongoing economic strength will likely continue to keep upward pressure on rates in the short-term,” Sam Khater, chief economist at Freddie Mac, said in a statement.
“As rates remain high and supply of unsold homes woefully low, incoming data shows that existing homes sales continue to fall,” he added. “However, there are slightly more new homes available, and sales of these new homes continue to rise, helping provide modest relief to the unyielding housing inventory predicament.
What are they saying? Other industry experts also believe rates could move higher.
“Earlier this year, it looked as though inflation was being brought under control and the Fed may be almost ready to declare victory… now, however, as inflation has ticked up and bond yields are rising amidst economic uncertainty, it is a different situation,” Lisa Sturtevant, chief economist at Bright MLS, said in a statement. “Instead of talking about rates falling to 6% this year, the question is how much above 7% are we going to go?”
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The numbers: Orders for long-lasting goods rose in July for the third month in a row if recent ups and downs at Boeing are set aside, suggesting the struggling industrial side of the U.S. economy may have stabilized.
Durable-goods orders increased 0.5% in July if transportation — automobiles and planes — are excluded. Boeing
BA,
orders often seesaw in the summer months and distort the true condition of U.S. manufacturing.
Headline orders, which include transportation, sank by 5.2% last month, the government said Thursday.
Economists polled by the Wall Street Journal had forecast a 4.1% drop in July following a 4.4% spike in June. The topsy-turvy results in the past two months are almost entirely due to Boeing.
A better measure of the health of U.S. manufacturing, known as core orders, edged up 0.1% in July. That figure omits defense and transportation and is a proxy for broader business investment.
Business investment is running slightly ahead of last year’s pace, but it has weakened considerably, and many manufacturers are treading water.
Key details: Orders for commercial planes soared 71% in June and sank 44% in July, explaining the wildly divergent headline numbers in the past two months.
Orders for new cars rose 0.8% in July.
The transportation segment is a large and volatile category that often exaggerates the ups and downs in manufacturing.
Outside the transportation sector, new orders rose in most major categories.
Business investment has tapered off since last year, however, and companies have become more cautious in the face of rising interest rates, still-high inflation and a shift in consumer spending toward services.
Durable goods are items like planes, cars, appliances and computers. Orders rise in an expanding economy and shrink in a contracting one.
Big picture: Maybe the industrial side of the economy has hit bottom, and maybe it hasn’t. Getting a clear picture might have to wait until interest rates stop rising.
Higher borrowing costs typically stunt the economy and discourage businesses from hiring, spending and investing.
Looking ahead: “Businesses are showing caution amidst the higher rate environment and what it means for demand down the line,” said economist Ali Jaffery at CIBC Economics.
Market reaction: The Dow Jones Industrial Average
DJIA,
and S&P 500
SPX,
were set to open mixed in Thursday trades.
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There’s one big, but theoretical, concept that has the potential to shake up the stock market the most on Friday, when Federal Reserve Chairman Jerome Powell is scheduled to deliver a speech at an annual symposium held in Jackson Hole, Wyo.
It has to do with the neutral rate of interest. That’s the level of real short-term interest rates that’s expected to prevail when the U.S. economy is at full strength and inflation is stable. The real neutral rate — known alternatively as r* or r-star— is estimated to be around 0.5%, after subtracting the Fed’s 2% inflation target from policy makers’ latest forecasts for where the fed funds rates is likely to be in the long run. And that neutral rate may be moving higher, given how the economy is performing right now.
Read: Jackson Hole meeting: When is Jerome Powell’s speech? What investors need to know.
Settling on the right theoretical level for the neutral rate matters because the U.S. economy appears to be accelerating, even after the Fed has hiked rates by more than five full percentage points to a 22-year high of 5.25%-5.5%. The world’s largest economy grew at a solid 2% pace in the first quarter, followed by a 2.4% pace for the second quarter. Now, the Atlanta Fed’s GDPNow model is forecasting a third-quarter growth rate of 5.8% for real gross domestic product — a number that’s drawn plenty of skeptics, but underscores just how well the economy seems to be doing.
See: R-Star Is the New Buzzword. Listen for It at Jackson Hole.
“The notion of a higher r-star or neutral rate has crept its way into the marketplace and has been a hot topic lately,” said Thomas Urano, co-chief investment officer at fixed-income money manager Sage Advisory in Austin, Texas, which oversaw $23 billion as of July. “The market is trying to digest where the Fed views this neutral rate and is looking to get a little more clarity as Powell speaks in Jackson Hole.”
If the neutral rate is higher than previously thought, that means policy makers might need to hike the fed-funds rate target even further, in addition to holding borrowing costs higher for longer and delaying the timing of their first rate cut.
Traders and investors are well aware that the Fed is likely to keep interest rates higher for longer, and they’ve pushed out their expectations about the timing of the first rate cut next year, according to Dan Eye, chief investment officer for Pennsylvania-based Fort Pitt Capital Group, which manages $4.9 billion in assets.
However, the market is not yet fully positioned for the Fed to put rate hikes back on the table, Eye said via phone on Wednesday.
Dow industrials
DJIA,
the S&P 500
SPX,
and Nasdaq Composite
COMP
are respectively up so far this year by 4.1%, 15.6%, and 31.3% as investors and traders hold out hope for a soft- or no-landing scenario in which the U.S. economy can emerge relatively unscathed as inflation keeps falling.
As of Wednesday afternoon, all three major stock indexes were higher, led by a 1.8% advance in the Nasdaq Composite as investors await a fiscal second-quarter earnings announcement from chip maker Nvidia Corp.
NVDA,
that’s due after the close.
Any remarks by Powell on Friday that can be interpreted as suggesting that more rate hikes are likely to come will produce volatility and “a downdraft in stocks,” Eye said. The best possible outcome for stock investors would be if Powell “stresses data dependency and says that policy makers will continue to consider the cumulative impact of rate hikes that have been done already.”
The theme of the Kansas City Fed’s Jackson Hole symposium, being held Thursday-Saturday, is “Structural Shifts in the Global Economy,” a topic that’s led to the growing expectation that Powell will address where he and the Fed currently see the neutral rate.
In the run-up to Friday’s Jackson Hole speech, the Treasury market has already priced in a scenario of better-than-expected U.S. economic growth, with 10- and 30-year yields reaching multiyear highs on Monday and last week. Though both yields pulled back on Tuesday and Wednesday, they could bounce back again if investors sell off long-dated government debt in response to Powell’s remarks, investors said.
The recent rise in yields has been blamed, in part, for August’s decline in U.S. stocks, with the S&P 500 down more than 3% so far this month.
“Powell has to sound hawkish, he cannot afford not to do so” because “any signal that the hiking cycle is done will probably lead to such a bullish response in risk assets that it will loosen broader financial conditions,” said strategist Rikkert Scholten at Rotterdam-based Robeco, which oversees $194 billion.
Still, Robeco’s investment team also expects the Fed chairman to stress data dependence as a way of “credibly” keeping his options open.
Brad Conger, deputy chief investment officer at Hirtle Callaghan & Co. in West Conshohocken, Penn., which manages $18.5 billion in assets, said he believes the Fed is near the end of its rate-hiking cycle, which began in March 2022.
Nevertheless, “any discussion about a higher natural rate of interest due to the shifting structure of the economy would set off a bout of uncertainty,” he said. Natural rate is the phrase used to describe where the neutral rate may settle over the longer run.
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“‘You could ask who is really running the show? Jerome Powell or Jensen Huang? Amazingly, it may not be Powell, but Jensen Huang who is driving Fed expectations.’”
Those are the words of Ben Emons, a senior portfolio manager and the head of fixed income at NewEdge Wealth in New York, who identifies reasons why artificial-intelligence leader Nvidia Corp.
NVDA,
is demonstrating central-bank-like powers.
It starts with the idea that the Santa Clara, California-based chip designer — which reports fiscal second-quarter earnings on Wednesday — acts as a bellwether for AI-capital expenditures that are likely to boost productivity across the U.S. economy. And in the bond market, a surge of AI-related expectations is translating into higher real yields, which reflect inflation-adjusted growth in gross domestic product and productivity, he said.
Read: Nvidia’s stock snaps losing streak and sits 1% below record close as earnings optimism builds
Higher real yields in the U.S. are a key reason why 10-
BX:TMUBMUSD10Y
and 30-year Treasury yields
BX:TMUBMUSD30Y
climbed to multi-year highs through Monday. Real yields, as measured by rates of Treasury inflation-protected securities, offer a glimpse of how the market expects the U.S. to perform when inflation isn’t a factor.
Read: Rise in Treasury yields is almost entirely due to one factor, strategist says
“The bigger macro story behind Nvidia as the bellwether of artificial intelligence is the role it plays in the economy, which is proving to be stronger than anyone thought it would be,” Emons said via phone on Tuesday. “People connect AI to productivity and productivity leads to growth, and to some extent this is impacting interest-rate expectations today.”
Amid growing anticipation over Nvidia’s upcoming earnings announcement and Friday’s speech by Federal Reserve Chairman Jerome Powell in Jackson Hole, Wyo., “the probability of a rate hike is creeping higher,” the senior portfolio manager wrote in a note this week. “With each additional dollar increase of NVDA EPS estimates, the probability of a hike by November goes up. NVDA is gaining Fed-like power.”
Need to Know: Nvidia may be the AI stock for now, but here are the picks for later, says Goldman Sachs
A chart provided by Emons shows how the median estimate of analysts for Nvidia’s earnings-per-share in the fiscal second quarter has been rising alongside the market-implied probabilities of a November Fed rate hike.
In addition, the yield on one of Nvidia’s own corporate bonds, issued in 2020 and maturing in April 2040, has been rising in relation to the 10-year TIPS or real yield “because of the company’s broader effect on the economy,” Emons said.
As University of Pennsylvania Wharton School finance professor Jeremy Siegel explained in a separate interview with MarketWatch, real interest rates track real growth. Improving productivity and stronger growth “mean the Fed won’t be able to cut rates as much as it would otherwise be able to.”
On Tuesday, Treasury yields finished mixed, while Nvidia’s shares closed down by 2.8%, as traders and investors await the company’s earnings report on Wednesday followed two days later by Powell’s remarks.
Analysts expect Powell to address what’s known as the real neutral rate of interest — or the inflation-adjusted level which is likely to prevail when the economy is operating at full strength and price gains are stable — as a way of justifying the higher-for-longer theme in U.S. interest rates.
See also: How higher-for-longer rates are playing out as 10-year yield hits 15-year high
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The recent rise in long-dated Treasury yields boils down to mostly one single thing, which is higher real rates resulting from changing expectations for U.S. economic growth, according to Joseph Kalish, chief global macro strategist at Ned Davis Research.
Kalish attributes 90% of the increase to that factor alone. He points out that 5-
BX:TMUBMUSD05Y,
7-
BX:TMUBMUSD07Y,
10-
BX:TMUBMUSD10Y
and 20-year Treasury yields are all up significantly since 2021-2022. On Tuesday, the 10-year rate finished at 4.327%, slightly off its almost 16-year high. Meanwhile, the 5-year Treasury yield, which reflects the intermediate part of the Treasury curve known as the belly, has trended higher as traders and investors factor in prospects for a stronger U.S. economy beyond the next few years.
Ordinarily, Treasury yields tend to rise based on a range of factors, such as the possibility of higher future inflation and investors’ demands to be compensated for that risk. This time around appears to be a bit different.
Real rates, as measured by yields on Treasury inflation-protected securities, reflect the market’s view of how the economy is performing after subtracting inflation. In other words, they present a purer read on how the U.S. is likely to do when inflation isn’t a factor. And right now, real yields are rising on the strength of recent economic data as investors hold out some hope for a soft landing, or scenario in which inflation comes down on its own without a recession or major jump in unemployment, or even no landing at all.
“Bond yields have come a long way in a short period of time,” Kalish wrote in a note distributed on Tuesday. “Nearly all of the rise has been due to higher real yields,” though an increase in the supply of U.S. government debt is also likely playing a contributing role.
As of Monday, 10- and 30-year Treasury yields
BX:TMUBMUSD30Y
had respectively jumped by 105.4 basis points and 91.7 basis points since early April, and closed at their highest levels since Nov. 6, 2007, and April 27, 2011. However, they ended lower on Tuesday at 4.327% and 4.410% as investors and traders took a break from the aggressive selloff of long-dated government debt seen over the past week.
The runup in Treasury yields has been blamed for a stock-market pullback, which has seen the S&P 500
SPX
retreat 4.4% so far in August. The large-cap benchmark remains up 14.3% so far this year.
As traders and investors await Federal Reserve Chairman Jerome Powell’s Jackson Hole address on Friday, Kalish wrote that “the market has been consistently underpricing the risk of additional rate hikes and overpricing the speed of rate cuts.” Powell will be “pleased at the progress on goods inflation, hopeful that the labor market is getting into better balance, but concerned about the economy growing faster than trend.”
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Economists don’t much like presidential-campaign seasons. For them, it’s a bit like seeing their manicured gardens getting trampled by schoolchildren having a water-balloon fight.
Robert Brusca, the president of consulting firm FAO Economics, predicted that the political discussion of the U.S. economy in the 2024 campaign would be “a farce.”
Talk of inflation is likely to dominate the Aug. 23 Republican debate, for example.
Republicans, eager to lay the blame for higher prices at the feet of President Joe Biden, are going to make the strongest case they can for that. For them, it is a happy coincidence that inflation started to pick up right when Biden was sworn into office.
Larry Kudlow, a former top economic adviser to President Donald Trump, put it succinctly. “I have numbers. The consumer-price index is up 16% since February 2021. Groceries are up 19%. Meat and poultry up 19%. New cars up 20%. Used cars up 34%,” Kudlow said in an interview on the Fox Business Network.
From last month: Mike Pence says inflation is 16%, but CPI is 3%. This is his logic.
Unlike Kudlow, the Federal Reserve doesn’t usually measure inflation over 29 months. Instead, the central bank favors using inflation data that looks at the past 12 months.
By that year-over-year measure, CPI is up 3.2%. Groceries are up 3.6%. Meat and poultry prices are up 0.5%. New-vehicle prices are up 3.5%, but prices of used cars and trucks are actually down 5.6%.
Economists, meanwhile, tend to like even shorter measures, such as the three-month annualized rate. They think the 12-month rate says more about the rate a year ago than it does about what is happening today.
“Looking at year-over-year [data], the only new piece of information is the current month. You are looking at 11 months that you already know,” said Omair Sharif, president and founder of research company Inflation Insights.
Using the shorter metric, headline CPI for the three months ending in July is up 1.9%, while food at home rose 1.1% and meat and poultry is down 4.5%, he said.
Trends have been favorable in recent months, but that might not last. “It’s been a good summer,” Sharif said. “But unfortunately, the winter data won’t be as pleasant.”
Economists tend not to blame one political party or the other for spikes in inflation.
In the 1970s, for example, the culprit was increases in oil prices by the Organization of Petroleum Exporting Countries.
This time, there was no one single factor. While the debate is not yet over, economists tend to focus on the pandemic, the war in Ukraine and the move to end reliance on fossil fuels in order to combat climate change.
Brian Bethune, an economics professor at Boston College, said prices started to rise when the healthcare industry had to adjust to a new, unforeseen risk. There were steep costs to dealing with the deadly coronavirus and developing vaccines.
People working in frontline industries were able to command higher wages. And demand outstripped supply for many things, as shelves were emptied by consumers and supply chains were strained.
Bethune also stressed recent moves toward renewable energy. The best way to explain inflation to your grandmother, he said, is to look at a chart of electricity prices.
The steady increase stems from efforts to move closer to a carbon-free economy, Bethune said. And those prices get passed along “right through the whole cost pressure of the economy,” including the price of refrigerated foods.
Inflation boomed and is now coming off its peak, said Brusca of FAO Economics. Prices are still rising, but not at the same rapid clip. And they won’t roll back to prepandemic levels.
“Consumers are caught in a trap,” he said. “If prices are going to come down, you have got to have deflation.”
Deflation comes with its own unique set of woes. It can make the cost of borrowed money, like mortgages, much more expensive. And it can lead to serious economic weakness.
“All of this is why the Fed targets price stability,” Brusca said.
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U.S. banks and regional banks fell across the board on Tuesday, after S&P Global Ratings downgraded five smaller players after a review of risk related to funding, liquidity and asset quality with a focus on office commercial real estate.
Adding to the gloom, Republic First Bancorp. Inc.’s stock
FRBK,
tanked by 39%, after Nasdaq told the company that its stock would be delisted on Wednesday, after it failed to file its annual report in time.
S&P’s move comes just days after Fitch Ratings analyst Christopher Wolfe reduced his operating environment score for U.S. banks to aa- from aa due to the unknown path of interest rate hikes and regulatory changes facing the sector.
And Moody’s Investors Service just two weeks ago upset investors when it downgraded some lenders and said it was reviewing ratings on bigger banks, including Bank of New York Mellon
BK,
State Street
STT,
and Northern Trust
NTRS,
For more, see: Bank asset quality, weaker profits spark Moody’s reviews and downgrades as it weighs potential 2024 recession
The S&P 500 Financials Sector has fallen for seven consecutive days, and is on pace for its longest losing streak since April 7, 2022, when it also fell for seven straight trading days.
Individual bank names are also performing poorly, with Goldman Sachs Group Inc.
GS,
and Citigroup Inc.
C,
down for 10 of the past 11 days and Charles Schwab Corp.
SCHW,
down 11 straight days.
Goldman alone has fallen for seven straight days for a total loss of 6.3%. It’s the longest losing streak since Feb. 28, 2020, when it also fell for seven straight days as the pandemic was taking hold.
The KBW Nasdaq Regional Banking Index
KBWR
is down for 11 straight days. and the KBW Nasdaq Bank Index
BKX
is down for seven straight days.
S&P downgraded Associated Banc. Corp.
ASB,
Comerica Inc.
CMA,
KeyCorp
KEY,
UMB Financial Corp.
UMBF,
% and Valley National Bancorp.
VLY,
by one notch and said the outlook on all five is stable.
Read also: More challenges await U.S. banks but analysts think the worst may be over for the year
The rating agency affirmed ratings on Zions Bancorp
ZION,
and maintained a negative outlook, meaning it could downgrade them again in the near-term. And it affirmed ratings and a stable outlook on Synovus Financial Corp.
SNV,
and Truist Financial Corp.
TFC,
“We reviewed these 10 banks because we identified them as having potential risks in multiple areas that could make them less resilient than similarly rated peers ,” S&P said in a statement.
“For instance, some that have seen greater deterioration in funding—-as indicated by sharply higher costs or substantial dependence on wholesale funding and brokered deposits—-may also have below-peer profitability, high unrealized losses on their assets, or meaningful exposure to CRE.”
The steep rise in interest rates orchestrated by the Federal Reserve over the past year has raised deposit costs as banks are now competing for savers seeking higher returns and that’s forced some to pay up on deposits and discourage their clients from heading to other institutions and instruments.
The sector has been skittish this year following the collapse of Silicon Valley Bank and other lenders that led to a run on deposits at a number of regional lenders.
However, S&P said about 90% of the banks it rates have stable outlooks and just 10% have negative ones. None have positive outlooks.
The widespread stable outlooks shows that stability in the U.S. banking sector has improved significantly in recent months.
S&P is expecting FDIC-backed banks in aggregate to earn a relatively healthy ROE of about 11% in 2023.
KeyCorp. and Comerica both fell more than 3% on the news. Of the two, KeyCorp. has more outstanding debt and its 10-year bonds widened by about 5 to 10 basis points, according to data solutions provider BondCliq Media Services.
As the following chart shows, the bonds have seen better selling on Wednesday with buyers emerging around midmorning.
The next chart shows customer flow over the last 10 days.
The next chart shows the outstanding debt of the downgraded banks, with KeyCorp. clearly the leader with almost $16 billion of bonds.
Don’t miss: Capital One confirms roughly $900 million sale of office loans as property sector wobbles
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Stocks closed mostly lower Friday, capping off a bruising week of losses as Treasury yields jumped and China’s mounting property woes gripped investors. The Dow Jones Industrial Average
DJIA,
rose about 27 points, or 0.1%, ending near 34,501, according to preliminary FactSet data. The S&P 500 index
SPX,
was nearly flat at 4,370 and the Nasdaq Composite Index
COMP,
shed 0.2%, despite briefly turning positive late in the session. It still was a tough week for equities, with the Dow booking a 2.2% loss, the S&P 500 index a 2.1% decline and the Nasdaq a 2.6%. The Nasdaq also posted its biggest 3-week decline since December 2022, according to Dow Jones Market Data. Yields on the 10-year Treasury rose for a 5th week in the row, with the benchmark
TMUBMUSD10Y,
rate briefly touching its highest level since November 2007, before settling back at 4.251% on Friday. China Evergrande’s
EGRNF,
Chapter 15 bankruptcy filing in New York late Thursday kept focus on the wobbling property market in the world’s second-largest economy. Earlier in the week, Country Garden Group missed a dollar-denominated debt payment. Next week investors will be focused on Federal Reserve Chairman Jerome Powell’s speech on Friday at the Jackson Hole economic summit for hints to whether the central bank is likely done hiking rates in this cycle. The Fed’s policy rate sits at its highest level in 22 years.
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The so-called Magnificent Seven grouping of technology stocks lost some of its luster this week after four of the seven moved into correction territory, meaning their stocks have fallen at least 10% from their recent peaks.
The corporate-bond market, in contrast, seems to like all seven names.
The group is made up of Facebook parent Meta Platforms Inc.
META,
Apple Inc.
AAPL,
Microsoft Corp.
MSFT,
Nvidia Corp.
NVDA,
Amazon. com Inc.
AMZN,
Google parent Alphabet Inc.
GOOGL,
GOOG,
and Tesla Inc.
TSLA,
One caveat: Tesla has no outstanding bonds. In the past, the electric-car maker issued convertible bonds, but they have all been converted into equity.
The group is credited with helping drive the stock market’s gains in the first half of the year, driven by excitement about artificial intelligence. But the rally has stalled in recent weeks as investors have fretted over the potential for U.S. interest-rate increases, surging Treasury yields and China worries, with property developer Evergrande filing for U.S. bankruptcy protection late Thursday.
On Thursday, Meta followed Apple, Microsoft and Nvidia into correction territory, as MarketWatch’s Emily Bary reported. Tesla, meanwhile, is in a bear market, meaning it’s down more than 20% from its recent peak.
Read: Have AI stocks like Nvidia reached bubble territory? Here’s what history can tell us.
The following series of charts from data-solutions provider BondCliQ Media Services show how many bonds each company has issued by maturity and how they have traded as the stocks have pulled back.
The first chart shows that Microsoft has by far the most bonds, mostly in the 30-year bucket. The software and cloud giant has more than $50 billion in long-term debt, according to its 2023 10-K filing with the Securities and Exchange Commission.
Source: BondCliQ Media Services
This chart shows trading volumes over the last 10 days, divided by trade type. The green shows customer buying, while the red is customer selling. The blue shows dealer-to-dealer flows. Microsoft, for example, has seen almost $1.3 billion in customer buying from dealers in the last 10 days and $960 million in customer sales to dealers.
Source: BondCliQ Media Services
This chart shows that every name in the group has enjoyed better net buying in the last 10 days, with Microsoft leading the way.
Source: BondCliQ Media Services
This chart shows spread performance over the last 50 days for an intermediate-term bond from each of the seven issuers. Most have tightened or remained steady over the period.
Source: BondCliQ Media Services
Read also: Red flags waving for tech stocks as AI bounce fades, China fears escalate
Apple’s stock entered correction Wednesday upon falling more than 10% from its July 31 peak of $196.45. The company sells mainly discretionary products, and right now “consumers are still being pinched” and thinking more carefully about where they spend their money, according to Matt Stucky, senior portfolio manager for equities at Northwestern Mutual Wealth Management.
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There is room for a continued selloff in U.S. Treasurys which has already pushed 10- and 30-year yields to their highest levels since 2007 and 2011, according to researchers at Barclays.Though the recent selloff took a breather on Friday, the steady drive higher in long-dated yields which unfolded this week left observers warning that the era of low rates may be firmly behind the U.S. as a new normal appears to take shape in the bond market. Long-term rates yields are just beginning to enter ranges that have been historically consistent with where they traded during the early 2000s.Read: Why Treasury yields keep rising,…
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Yearly returns in the Treasury market slipped into negative territory this week as the market sold off on signs that the Federal Reserve may need to keep rates high for a while to contain inflation.
While negative returns might stir bad memories of last year’s shocking losses for bonds, stocks and nearly everything else, investors holding Treasury debt issued at 2023’s higher yields might want to sit back and take stock.
“This is the top thing we hear,” said Ryan Murphy, director of fixed-income business development at Capital Group, of evaporating returns in what’s been a tough August. “You saw the worst bond market in 40 years last year. Investors, they are tired, and feel beaten up.”
Murphy’s message to clients is this: “In bonds, you earn the money over time.” And those dwindling bond returns since January? “Approach it with a deep breath, and know this is going to work out in the end.”
Capital Group’s laid-back style and lack of “a star CEO” earned it recognition by Institutional Investor in March as “a new bond leader” without a king, in large part because it attracted $100 billion in funds over the past five years, or twice the total of its peers.
Recent volatility in interest rates again zapped yearly gains in many bond funds, as Fed officials continued to warn that a roaring labor market and robust spending could keep inflation from receding to the central bank’s 2% annual target.
The spike in long-term bond yields makes older, lower-yielding securities look comparatively less attractive. That’s reflected in the yearly return on a key Bloomberg U.S. government bond and note index, which turned negative for the first time since March (see chart), when several regional banks failed, stoking fears of a broader banking crisis.
FactSet
However, a look back at August 2022 shows the 10-year Treasury yield starting around 2.6%, according to FactSet.
By contrast, Treasury bill yields
BX:TMUBMUSD06M
neared 5.5% on Thursday, or “north of anything we’ve seen over the past 15 years,” Murphy said. And for investors looking to lock in longer-term yields, the 10-year Treasury rate
BX:TMUBMUSD10Y
touched 4.307% on Thursday, its highest level since November 2007, according to Dow Jones Market Data.
See: How BlackRock’s Rick Rieder is steering his active fixed-income ETF as bond funds struggle
“It’s becoming more expensive for the government and companies to finance debt because of the rapid climb in rates,” Murphy said of the drag of higher long-term interest rates.
On the flip side, it’s also been one of the best stretches for lenders and bond investors in terms of getting paid to act as creditors since the 2007-2008 global financial crisis, but without a U.S. recession — or at least not yet.
What’s also different from last year is that the Fed already jacked up interest rates to a 22-year high of 5.25%-5.5% in July, and has signaled it’s likely nearly finished with hikes in this cycle.
Murphy pointed to a mountain of cash on the sidelines, in the form of assets in money-market funds, as another potential stabilizer for markets.
Assets in money-market funds hit a record $5.57 trillion for the week ending Wednesday, according to data from the Investment Company Institute.
“What’s really interesting is that there’s been two bursts of investors going into money-market funds. There was a big shift right at the onset of COVID, and another burst over the past 12-18 months since the beginning of the rate-hiking cycle,” Murphy said.
Looking back to 2008, he pointed to a similar buildup in money-market assets, and a roughly $1.1 trillion wall of cash subsequently leaving the sector, as financial assets began to recover in the wake of the financial crisis.
“What we did see, while not all of it, was a healthy amount went back into fixed-income in the following years,” Murphy said.
Stocks closed lower Thursday and were headed for another week of losses, with the Dow Jones Industrial Average
DJIA
2.3% lower on the week so far, the S&P 500 index
SPX
down 2.1% and the Nasdaq Composite Index off 2.4%, according to FactSet.
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U.S. stocks posted back-to-back losses Wednesday after Federal Reserve minutes of its July meetings showed concerns about inflation revving back up. The Dow Jones Industrial Average DJIA fell about 180 points, or 0.5%, ending near 34,765, according to preliminary FactSet data. The S&P 500 index SPX gave up 0.8% and the Nasdaq Composite Index COMP closed 1.2% lower. All three benchmarks booked back-to-back loses, while the S&P 500 ending at its lowest level in more than a month. Minutes of the Fed’s July 25-26 meeting said “most participants continue to see significant upside risks to inflation, which could require further…
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U.S. stocks closed sharply lower Tuesday as investors monitored signs of China’s darkening economic backdrop and gauged if a robust U.S. consumer could spell more Federal Reserve rate hikes. The Dow Jones Industrial Average DJIA fell about 360 points, or 1%, to about 34,946, according to preliminary FactSet data. The S&P 500 index SPX dropped 1.2% to about 4,437, its lowest close since mid-July, according to FactSet. The Nasdaq Composite Index COMP ended 1.1% lower. Chinese retail sales and industrial production in the world’s second biggest economy grew less than expected in July. Its growing property woes also contributed…
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