Last Week in Review – August 7, 2023 – from Stephen Colavito
The major U.S. equity benchmarks started August down last week after closing out a strong July. Stocks declined amid rising Treasury yields and an unexpected downgrade to the U.S. government’s credit rating. The technology-heavy Nasdaq Composite suffered the largest losses for the week.
In a busy week for corporate earnings releases, investors were primarily focused on results from mega-cap names Amazon and Apple, which reported earnings after markets closed on Thursday. Amazon significantly beat expectations, helped by strength in its core retail business, and the company’s stock rallied more than 9% at Friday’s open. Meanwhile, Apple traded down about 3% after a mixed report showing strength in its services business, although iPhone sales disappointed.
US - MARKETS & ECONOMY
The Labor Department’s closely watched monthly nonfarm payroll report showed that employers added 187,000 jobs in July, about the same as June’s downwardly revised 185,000. The past two months’ data, while still showing health in the labor market, point to a notable slowing from the first five months of the year when the economy added an average of 287,000 jobs a month. The unemployment rate ticked down to 3.5% from 3.6% the prior month, while wages grew 4.4% over the 12 months, unchanged from June.
Earlier in the week, the Job Openings and Labor Turnover Survey from the Bureau of Labor Statistics showed a modest drop in the number of job openings in June, although layoffs declined for a third straight month. ADP’s private employment survey was better than expected but did show that hiring eased to 324,000 from 455,000 in June. In non-labor market news, the Institute for Supply Management manufacturing Purchasing Managers’ Index came in at 46.4, a bit lower than the 46.9 consensus, and the ninth straight month under 50, the level that indicates contraction.
US YIELDS & BONDS
On Tuesday, Fitch Ratings downgraded U.S. government debt's credit rating from the highest level, AAA, to AA+, with the rating agency saying its decision “reflects governance and medium-term fiscal challenges.” Traders we spoke with noted that it was the first negative surprise that markets have had to deal with in some time, and some investors seemed to use the news as an excellent excuse to reduce riskier positions. S&P also has an AA+ rating in the U.S., following a downgrade in 2011.
The yield on the benchmark 10-year U.S. Treasury note increased from 3.95% at the end of the previous week to almost 4.20% by early Friday but decreased to about 4.05% following the jobs report's release. Expectations for higher issuance levels by the Treasury Department helped push yields higher earlier in the week. The tax-exempt municipal bond market started August on a weaker footing alongside the sell-off in Treasuries. The interest rate volatility and softer macro tone countered the technical tailwind of August reinvestment cash and negative net supply. In the primary market, some deals did not receive adequate demand and needed to be adjusted.
In the investment-grade corporate bond sector, traders noted that issuance was oversubscribed throughout the week. Meanwhile, the high-yield corporate bond market traded lower as Fitch’s downgrade of U.S. debt fostered broad risk-off sentiment. The primary market remained active, with several new deals announced. However, investors were somewhat selective as there was tepid demand for a few issues while other higher-quality deals continued to trade well.
US TREASURY MARKETS – CURRENT RATE AND WEEKLY CHANGE
3 Mth -0.01 bps to 5.40%
2-yr: -0.11 bps to 4.76%
5-yr: -0.05 bps to 4.13%
10-yr: +0.08 bps to 4.03%
30-yr: +0.19 bps to 4.20%
INTERESTING NEWS OVERSEAS
The pan-European STOXX Europe 600 Index ended 2.44% lower in local currency terms. Higher U.S. bond yields and disappointing European earnings reports deflated investor enthusiasm for riskier assets. Major country stock indexes also declined. Germany’s DAX dropped 3.14%, France’s CAC 40 Index lost 2.16%, and Italy’s FTSE MIB slid 3.10%. The UK’s FTSE 100 Index fell 1.69%.
European government bond yields broadly climbed as resilient economic data suggested a global recession might be avoided. The benchmark 10-year German government bond yield rose to its highest level since March. In the UK, the benchmark 10-year government bond yield stabilized below 4.5% after the Bank of England (BoE) raised borrowing costs for a 14th consecutive time.
The BoE raised its key interest rate by a quarter of a percentage point to a 15-year high of 5.25%. It warned that rates were likely to stay high for some time, saying, "The MPC [Monetary Policy Committee] will ensure that Bank Rate is sufficiently restrictive for sufficiently long to return inflation to the 2% target." The central bank predicted the inflation rate would fall to 4.9% by the end of this year, a faster pace than in its May forecast. BoE estimates for economic growth were little changed at 0.5% this year and next.
With global investor risk appetite dampened by a U.S. sovereign credit rating downgrade, Japan’s stock markets fell over the week. The Nikkei 225 Index registered a 1.7% loss, and the broader TOPIX Index was down 0.7%. Despite the support provided domestically by a solid corporate earnings season, many companies saw output recover post-pandemic and benefited from the weak yen and rising prices.
The yield on the 10-year Japanese government bond (JGB) rose to 0.65%, around a nine-year high, from 0.55% at the end of the previous week. This followed the Bank of Japan’s (BoJ’s) July monetary policy tweak to effectively allow interest rates to rise more freely by increasing the flexibility around its yield curve control target, as well as its offer to buy 10-year JGBs at 1.0% (up from 0.5%) each day. During the week, the BoJ announced two unscheduled bond-purchase operations aimed at slowing the speed of yield gains. BoJ Governor Kazuo Ueda has said that he does not expect yields to rise to 1% under current circumstances.
Given the BoJ’s continued commitment to its accommodative stance and Japan’s wide interest rate differential with the U.S., the yen weakened to about JPY 142.6 against the U.S. dollar, from around 141.1 the prior week. Speculation was ongoing that Japan’s Ministry of Finance could intervene in the foreign exchange markets to shore up the yen’s value.
Lastly, Chinese stocks rose as Beijing’s supportive stance offset concerns about the latest batch of disappointing economic data. The Shanghai Stock Exchange Index gained 0.37%, while the blue-chip CSI 300 advanced 0.7%.
China's State Council cabinet announced new measures to revive consumption. Reuters reported that the wide-ranging policies focused on removing restrictions on consumption in sectors including autos, real estate, and services. Local regions were also encouraged to provide subsidies for home appliance purchases and renovation materials in rural areas. However, the measures did not mention direct cash support to consumers to bolster spending, which some analysts have called for.
THE WEEK AHEAD
The flow of earnings releases in the US is expected to slow down. However, investors can still anticipate major reports from prominent companies such as The Walt Disney Co, AMC Entertainment, Novo Nordisk, Barrick Gold, Eli Lilly and Co, Take-Two Interactive Software, Twilio, and Upstart Holdings.
On the economic data front, all eyes will be on the CPI report scheduled for Thursday. Investors expect the inflation rate to accelerate to 3.3% from 3% in June, marking the first increase in headline inflation since June 2022, mainly reflecting base-year effects from energy costs. The core rate is steady at 4.8%, remaining well above the Federal Reserve's 2 percent target. Other crucial economic releases include the preliminary estimate of Michigan Consumer Sentiment, producer prices, foreign trade data, IBD/TIPP Economic Optimism Index, and the government's monthly budget statement.
Have a great week.
Stephen Colavito
Chief Investment Officer
San Blas Securities
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