The last week’s market highlights:
Quote of the week:
“I don't wanna grow up. I'm a Toys ‘R’ Us kid.” – TV ad for retailer Toys “R” Us
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.
U.S. economy: More evidence of labor market tightness (without higher wages)
U.S. employers added 157,000 payrolls in July, below expectations for around 190,000. The somewhat slower job creation was due in part to the closure of retailer Toys “R” US at the end of June. However, employment gains for May (+24,000) and June (+35,000) were revised up to 268,000 and 248,000, respectively. This raised average monthly job growth to a strong 200,000 over the past 12 months and an even-better 224,000 over the prior three months. In our view, this faster recent pace of job creation can’t be sustained much longer, mostly because the U-6 unemployment rate—which includes those workers who are marginally attached to the labor force or are working part-time for economic reasons—fell to a 17-year low of 7.5%. As a result, the labor force participation rate, which stayed at 62.9%, will likely struggle to increase further.
Unfortunately, labor-market strength has not translated to faster pay growth. To illustrate, for the 12 months ending July 2018, average hourly earnings (AHE) have risen 2.7%. That’s essentially the same rate of increase seen from August 2015-July 2017 despite a drop in the unemployment rate from 5.1% to 3.9% over the past three years.
Demographics are partly to blame for the lack of AHE acceleration. A large number of retiring baby boomers, many of whom were relatively well paid, have been replaced by millennials and the long-term unemployed re-entering the work force. Both of these groups generally receive lower wages. This shift has contributed to muted gains in AHE.
Last week’s other data releases for July were mixed. Among the highlights:
- Manufacturing slipped to 58.1 but stayed well above the 50 mark separating expansion from contraction, according to the manufacturing gauge published by the Institute for Supply Management (ISM). New orders—a leading indicator of economic activity—remained strong, and inventories grew. While supply chain bottlenecks eased, they persisted nonetheless.
- Service-sector activity slumped to an 11-month low of 55.7, with the ISM index hurt by weakening exports and new orders.
- Consumer confidence improved, according to The Conference Board. Although consumers remain optimistic about the current state of the economy, in recent months they’ve become less excited over its longer-term prospects.
Policy watch: The Fed’s gone fishing…for now
The Federal Reserve made no concrete policy changes at its August 1 meeting but made clear it intends to continue normalizing interest rates, with further hikes as needed this year to ensure the economy doesn’t overheat. Moreover, the Fed believes its dual mandate of full employment and 2% annual inflation has been achieved. Some version of the word “strong” appeared no fewer than four times in the opening paragraph of the Fed’s policy statement alone.
Although markets expected no action at this meeting, they continue to price in quarterly hikes in the fed funds rate through the middle of 2019. By then, the Fed may have reached its longer-run range of 2.75% to 3.00%. The inflation rate over the past year—as measured by the Fed’s preferred barometer, the core PCE price index—was 1.9%, just shy of its 2% target. Moreover, unemployment remains well below its long-run average after falling to 3.9% in July.
Cumulatively, the Fed’s seven 25-basis-point hikes since December 2015 have lifted short-term U.S. interest rates and flattened the Treasury yield curve. Such flattening occurs when the gap between yields on longer-term securities (like the 10-year note) and shorter-dated debt (like the 3-month bill) narrows. This trend is quite normal in the later stages of an economic expansion. However, an inverted yield curve—when shorter-term yields exceed longer-term yields—has historically been a harbinger of an approaching recession.
The Fed has come under criticism by none other than the U.S. president, who publicly lamented that monetary policy tightening may harm the ability for looser fiscal policy to boost growth. We are not surprised to see a politician pine for more dovish (i.e., stimulative) monetary policy, nor do we think the Fed will respond to outside pressure—in either direction—in its decision making process. The rapid acceleration of inflation in Turkey, along with the collapse of the Turkish lira this year as the central bank has been slow to raise rates, provides clear evidence of the importance of a domestic monetary policy free from the whims of the political moment.