The last week’s market highlights:
Quote of the week:
“The top of one mountain is always the bottom of another.” – Marianne Williamson
Each week, we present our featured topics in the context of the major themes listed below from the Nuveen Midyear Outlook:
- U.S. economy: Running ahead of its peers.
- Global economy: Trade a bigger concern outside the U.S.
- Policy watch: Central banks aren’t all on the same wavelength.
- Fixed income: Starting to prefer higher-quality assets.
- Equities: Earnings are supporting prices, but expect plenty more volatility.
- Asset allocation: Remain risk on, but focus on quality.
Policy watch: Tighten your seatbelts, the Fed is coming
It will be a shock if the Federal Reserve (Fed) chooses not to raise interest rates at its September 26 meeting. Beyond the hike itself, we expect to see slightly higher forecasts for growth and, potentially, firmer projections for further rate hikes over the next several quarters.
The last time the Fed raised rates was in June. Since then, U.S. economic conditions have, on net, strengthened. Business and consumer confidence are higher, private-sector spending remains solid and trade risks have yet to manifest themselves as observable headwinds to growth.
Against this backdrop, we expect the Fed to continue its pattern of quarterly tightening this week, with another 25-basis-point (0.25%) increase in the target federal funds rate, to a range of 2.00%-2.25%. Along with this action, Fed officials will release updated forecasts for growth, inflation, unemployment and interest rates. These outlooks are likely to show a somewhat faster pace of economic expansion and a broader consensus for another hike in December, as well as several more in 2019.
Chairman Jerome Powell will hold a post-meeting news conference, at which he is sure to be pressed on the risks of a global trade war. We think he’ll downplay its potential impact in light of the stimulus-fueled acceleration of the U.S. economy.
In anticipation of the Fed’s action, the 2-year Treasury yield punched through the 2.80% level for the first time since 2008, closing at 2.81% on September 21. Meanwhile, the yield on the bellwether 10-year Treasury note finally cleared the 3% hurdle that for months had acted as a ceiling. The 10-year ended the week at 3.06%. Barring a deterioration in risk appetite, such as one driven by a 3%-5% drop in stock prices, we expect the 10-year yield to rise modestly further in 2018.
In non-Treasury fixed income markets, high-yield bonds saw their seven-day winning streak snapped, finishing the week essentially flat. The asset class, which has rallied from negative territory in late May to post a 2.4% gain for the year to date through September 21, has benefited from weak supply and strong demand amid declining fears of a recession. In contrast, investment-grade bonds struggled last week. Year to date, they’ve lost 2.5%.
U.S. economy: Last week’s data docket “homed in” on housing
In a generally light week for U.S. economic data releases, investors got a glimpse into the health of the U.S. housing market. Housing numbers overall have been disappointing in 2018. Residential investment has been sluggish, as the private sector has focused more on upgrading machinery and software. Most construction has been for commercial purposes. But last week, the residential real estate sector received some positive news:
- Homebuilders are still optimistic, with the NAHB/Wells Fargo Index holding firm at 67 in September. (Levels above 50 indicate that more builders believe conditions are good than poor.) Despite rising home prices, which have kept some would-be buyers on the sidelines throughout the year, demand has remained firm and is expected to stay so over the next six months. A drop in lumber prices from the summer’s record-high levels also boosted sentiment.
- The AIA Architecture Billings Index, a leading indicator for construction activity, advanced to a seven-month peak in August. This is a favorable sign, as activity tends to slow in the summer.
- Housing starts jumped 9.2% in August, while existing home sales held steady after declining for four straight months.
To be sure, the housing sector faces further headwinds, including steep prices for materials and rising mortgage rates, which are likely to head even higher if the Fed continues on its tightening path, as we expect. Tariffs pose a concern, too. According to the NAHB, the latest U.S. tariffs on China include about $10 billion worth of goods used by the residential construction sector. A 10% levy on those products represents a $1 billion tax on the housing industry.
Non-housing data released last week also showed further U.S. economic strength:
- First-time unemployment claims dipped to 201,000, while the less-volatile four-week moving average also fell, to 204,750. Both are at their lowest levels since 1969. Continuing jobless claims, which represent the number of people already receiving benefits, reached a 45-year low.
- The Conference Board’s index of leading economic indicators (LEI) increased for the 11th consecutive month in August. According to the press release accompanying the data, LEI is pointing to 3% GDP growth for the rest of 2018.
- Although Markit’s “flash” Composite PMIs declined to 53.4 in September, the effects of Hurricane Florence likely contributed to the downturn. On the positive side, new orders growth accelerated, backlogs of work rose due to the weather-related disruptions, and hiring picked up.