The last week’s market highlights:
Quote of the week:
“So just as I want pilots on the planes that I fly, when it comes to monetary policy, I want to think that there is someone with sound judgment at the controls.” – Martin Feldstein
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2Q 2019 Outlook :
- U.S. economy: Late cycle but no recession
- Global economy: Slower this year than last
- Policy watch: A dovish turn for global central banks
- Fixed income: Rates likelier to rise than fall
- Equities: Get defensive, stay invested
- Asset allocation: Still favorable to emerging-market assets
Policy watch: Tune out the markets, tune in to data
What will the Federal Reserve do next?
Investors seem pretty certain that the Fed will cut interest rates by the end of the summer. Indeed, fed funds futures—used by traders to bet on the likelihood of a rate change—currently show a 97% chance of such a move by September, up from just 32% on May 1, the date of the last Fed meeting. Treasury markets also anticipate easier Fed policy. Long-term Treasury yields remained near their recent lows, with the 10-year closing at 2.09% on June 14. Meanwhile, U.S. stocks maintained their June momentum, due in large part to hopes that lower rates are forthcoming. The S&P 500 Index finished last week just slightly below its all-time peak.
But do financial market expectations and activity make the most persuasive case for a summertime cut? We prefer to zero in on economic data.
Last week’s data releases were mixed to positive. According to April’s JOLTS report, the number of job openings stayed close to historical highs. And the NFIB Small Business Optimism Index jumped in May (more on that below). May retail sales data helped end the week on a high note, coming in above expectations, with an upward revision to April sales.
Inflation, though, increased just 1.8% in May compared to a year ago, as measured by the Consumer Price Index (CPI). That’s below the Fed’s 2% target. Stripping out food and energy prices, year-over-year CPI inflation was 2%, down from 2.1% in April. Even policy doves would likely agree that this level of inflation alone doesn’t justify a shift to lower rates. But when sluggish inflation is factored in alongside other key data points, the prospect of a rate cut may not be far-fetched.
- Annual growth in capital goods orders has fallen sharply over the past year.
- The pace of job creation has slowed dramatically since February.
- Real personal spending has risen in only two of the past five months.
- Higher tariffs on Chinese goods have offset some of the stimulus from last year’s individual and corporate tax cuts.
Weaker economic growth, tepid inflation and less accommodative fiscal policy (courtesy of the tariffs) have prevailed in the second quarter. But that follows a first quarter in which the U.S. economy grew at a healthy 3.1% annualized pace. In our view, the recent downshifts call merely for the Fed to pause, not reverse course. This would allow Chair Jerome Powell and his colleagues to assess the cumulative effects of the four rate hikes they implemented in 2018.
What would be the most compelling rationale for lowering rates in July? To protect the economy from a potential tariff-fueled slowdown. President Trump has vowed to impose a 25% tariff on a further $300 billion of Chinese imports unless China’s President Xi Jinping meets with him at the G-20 Summit on June 28-29. Moreover, Trump may increasingly use tariffs as a political tool, much as he did in threatening Mexico if its government didn’t agree to step up border security.
Attempting to steer monetary policy to counteract higher import taxes that might be levied isn’t an approach found in many economics textbooks. Nonetheless, the potential negative impact of the U.S./China trade war could be substantial. Even if escalating tariffs won’t directly push the economy into recession, they could result in lost business and consumer confidence, lower stock prices and a stronger dollar.
U.S. economy: Big plans for small businesses
Given ongoing trade tensions, it’s no surprise that business optimism surveys around the world show respondents have become less…optimistic. They’re concerned about the global economic outlook and the likelihood of a slowdown.
But not here at home. Small businesses in the U.S. actually became more bullish last month, despite a ratcheting up of the U.S./China trade dispute. According to the NFIB Optimism Index, a higher percentage of business owners plan to hire, increase wages and boost capital spending compared to earlier in the year.
This surge in sentiment to historically high levels runs contrary to rising expectations of Fed rate cuts and sharply lower Treasury yields, which often presage an economic slowdown. The better mood is also at odds with Purchasing Manager Index (PMI) surveys conducted in May. PMIs poll larger companies. Why the differing perspectives?
Because they’ve historically shouldered a heftier average tax burden, small firms in the U.S. were more likely to benefit from last year’s cuts in corporate and individual tax rates. Small companies have also been known to express frustration with federal regulations. Therefore, they were particularly enthusiastic in their embrace of the Trump administration’s elimination of so-called “red tape.”
The percentage of small businesses reporting difficulty filling open positions remained high, a sign of tight labor markets and one factor driving up compensation plans over the next several months. With more hiring, more investment and fatter paychecks on the way—helped by a reduced tax and regulatory burden—this significant segment of the U.S. economy continues to look strong despite the market’s periodic fears of recession.