The last week’s market highlights:
Quote of the week:
“If it hurts too much, make it hurt someone else instead.” – Robert Jordan
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s Midyear Outlook :
- U.S. economy: Late cycle but no recession
- Global economy: Still looking for a bottom
- Policy watch: Easy monetary policy to offset restrictive trade policy
- Fixed income: Volatile interest rates but no breakout in either direction
- Equities: Get defensive, stay invested
- Asset allocation: No longer “risk on,” but still prefer emerging-market bonds
Policy watch: The Fed takes out insurance
The Federal Reserve heeded the market’s call to lower interest rates last week, reducing its target range for the federal funds rate by 25 basis points (0.25%), to 2.00%-2.25%. Futures markets had fully priced in the move after Chair Jerome Powell sounded a dovish tone in his recent public comments on Capitol Hill. In addition to the rate cut, the Fed elected to end its balance-sheet reduction plan (also known as quantitative tightening) on August 1, two months earlier than initially scheduled. As a result of this change in policy, the Fed resumed reinvesting the monthly proceeds of Treasury and mortgage-backed securities, providing liquidity for markets.
The last time the Fed cut rates, in December 2008, the U.S. economy was in the grips of the Great Recession. Employers were shedding payrolls by the hundreds of thousands each month, and consumers were raising the white flag of surrender. Now? An entirely different story. By our account, the U.S. economy still looks resilient as it enters its 122nd consecutive month of expansion, the longest on record. Here’s some recent evidence:
- Employers added 164,000 payrolls in July, the 21st time since July 2017 that job gains have topped 150,000.
- Consumer confidence jumped in July to its highest level of the year, according to The Conference Board’s index.
- Household balance sheets are in good shape. The savings rate rose to 8.1% in June, thanks in part to data revisions showing consumers have been spending less of their income than previously thought.
- A combination of plentiful jobs, strong stock market gains and rising home values, and accelerating wage growth propelled consumer spending in the second quarter. Consumer spending makes up about two-thirds of GDP.
So with the economy on sound footing and the Fed’s dual mandate of price stability and full employment close to being fulfilled, why did the Fed take the plunge?
Powell and his colleagues have frequently cited slow global growth and policy uncertainty—whether related to trade, Brexit or geopolitical tensions—as the main sources of downside risk to their outlook. And these two headwinds seem to have intensified. On the growth front, data released last week revealed that China’s manufacturing sector contracted for the third month in a row in July, and eurozone GDP expanded at a weak 1.1% annualized rate in the second quarter. As for policy uncertainty, President Trump shook markets the day after the Fed meeting by threatening to impose a 10% tariff on $300 billion of Chinese imports in September, thus shattering a shaky truce reached in late June with China’s president, Xi Jinping.
The Fed believes that reducing interest rates acts as a low-cost insurance policy against a future decline in economic conditions. That said, we doubt that last week’s rate cut—or even multiple cuts before year-end—will provide much of a boost to the U.S. economy. Since the Fed’s last rate hike in December 2018, stocks have rallied while Treasury yields have fallen, making it easier for businesses to borrow. Consequently, financial conditions have become more conducive to growth without the Fed’s lowering interest rates.
U.S. economy: The trade tiff obscures further evidence of job-market strength
Normally, the monthly U.S. employment release is “must reading” for investors. But last week’s surprise tariff announcement took the market’s eyes off what would otherwise be a solid July jobs report. Economists earned their money, with consensus forecasts (163,000 payrolls) nearly matching the actual figure (164,000). One negative note: employment gains for May and June were revised downward by a combined 41,000.
The unemployment rate remained near a multi-decade low of 3.7%, and for a good reason: more people entered the labor force. Indeed, the labor force participation rate ticked up to 63%, while the U-6 “underemployment” rate fell to 7.0%, its lowest level since 2000. (The U-6 rate includes discouraged workers who have quit looking for a job and part-time workers seeking full-time employment.) Some market commentators have suggested that the unemployment rate has stayed artificially low because many people seeking full-time positions are stuck in part-time jobs. Data doesn’t bear that out, however. The number of workers reporting frustration about finding full-time employment fell below four million for the first time since 2006, which is the lowest percentage of the overall population since 2001.
Wages showed continued signs of life, which could complicate matters for the Fed if it plans to continue cutting interest rates. Average hourly earnings (AHE) increased 0.3% in July after June’s 0.3% upward revision, which translates to healthy 3.2% year-over-year wage growth.
Although paychecks have fattened, job creation has stayed on its recent slower trajectory, reflecting a shrinking pool of available workers. The economy has added 140,000 payrolls per month on average over the past three months versus 165,000 for the year to date. Still, these are respectable numbers for the labor market, particularly in the eleventh year of an expansion. The late-cycle hiring boost in 2017 and 2018, when the economy added around 200,000 workers a month, was fueled in large part by tax cuts and extra government spending. We’re returning to a more moderate pace of job growth that we might have experienced without the benefit of that fiscal stimulus.