Last Week in Review – July 31, 2023 – from Stephen Colavito
Last week stocks ended higher, most notable for the Dow Jones Industrial Average’s notching its 13th consecutive daily gain on Wednesday, which marked its longest winning streak since 1987. Trading was relatively subdued as the summer vacation season diverted some focus on important data releases, a Federal Reserve (Fed) policy meeting, and some high-profile corporate earnings reports. Growth stocks handily outpaced their value counterparts, and the technology-heavy Nasdaq Composite led the gains.
Sentiment appeared to get a boost from a series of generally favorable economic readings, particularly on inflation. Stocks opened sharply higher on Friday, following news that the Fed’s preferred inflation gauge, the core (less food and energy) personal consumption expenditures (PCE) price index, had risen 0.2% in June, down from 0.3% in May, making for a year-over-year increase of 4.1%, a tick lower than expectations and the slowest increase since September 2021. In addition, the employment cost index—closely watched because of policymakers’ continued concern about wage inflation—rose 1.0% in the second quarter, below consensus and the smallest increase in two years.
US - MARKETS & ECONOMY
Moreover, the week’s data suggested that the economy might manage a soft landing and skirt a recession even as borrowing costs increased. On Wednesday, the Commerce Department reported that the economy had expanded at a year-over-year pace of 2.4% in the quarter, well above the previous quarter’s growth rate of 2.0% and consensus expectations of around 1.8%. Both businesses and consumers appeared to remain in good shape and spending freely. Durable goods orders jumped 4.7% in June, while personal spending rose 0.5%. Pending home sales also rose unexpectedly.
The Fed announced a 0.25% increase in the federal funds target rate following the conclusion of its two-day policy meeting on Wednesday, as expected. The tone of the Fed’s official statement was received as relatively benign, however, and expectations grew that the Fed was done raising rates, at least for the year. In his post-meeting press conference, Fed Chair Jerome Powell acknowledged that “restrictive” monetary policy was now “putting downward pressure on economic growth and inflation.” Still, he stressed that incoming data would guide further changes to interest rates. According to the CME Fed Watch Tool, futures markets ended the week pricing in only a 27.4% chance of further rate hikes by the end of the year compared with a 90.8% chance the week before.
US YIELDS & BONDS
Reassuring inflation data helped push down U.S. Treasury yields somewhat, but the yield on the benchmark 10-year note still ended the week sharply higher on the solid growth signals. (Bond prices and yields move in opposite directions.) According to our traders, the tax-exempt municipal bond market had a relatively quiet week, but recent new issues performed well, led by higher-yielding bonds.
Spreads tightened throughout the week in the investment-grade corporate bond market, led by mid-tier banks. Thanks to light new supply and a very active market in collateralized loan obligations, investment-grade securitized credit, including asset- and commercial mortgage-backed securities, also outperformed.
High-yield securities felt pressure as risk assets turned lower on news that the Bank of Japan (BoJ) had announced a potential change to its yield curve control policy (see below). Although a few new deals were announced, early August is expected to be busier regarding primary issuance. Meanwhile, loan investors mainly focused on the primary calendar and single-name headlines amid earnings season.
US TREASURY MARKETS – CURRENT RATE AND WEEKLY CHANGE
3 Mth +0.01 bps to 5.41%
2-yr: +0.03 bps to 4.87%
5-yr: +0.09 bps to 4.18%
10-yr: +0.12 bps to 3.95%
30-yr: +0.11 bps to 4.01%
INTERESTING NEWS OVERSEAS
Eurozone bond yields climbed on concerns that the prospect of higher Japanese yields (see Japan section for details) could prompt an exodus of Japanese investors from that market, but yields steadied as the week wound down. For example, the yield on Germany's 10-year sovereign bond rose above 2.56% before finishing the week around 2.49%. Swiss and French bonds experienced similar volatility. UK government bond yields also ended higher.
The week started cautiously following an inconclusive election outcome in Spain. The country faces near-term uncertainty as parties at each end of the political spectrum jockey to form a majority coalition government or face another election.
Data released in the week showed a slowdown in regional business activity. The Flash Eurozone Composite PMI Index, an initial gauge of activity in the manufacturing and services sectors, fell to an eight-month low of 48.9 in July from 49.9 in June. At a country level, Purchasing Managers’ Index (PMI) readings in France and Germany were both weaker for the month.
In Germany, the IFO business climate index fell for the third straight month to 87.3 in July from 88.6 the previous month. On an encouraging note, the UK business sentiment index recorded a positive score for the three months to July.
The ECB increased interest rates to a record-equaling high of 3.75% in a primarily expected move. The bank cited the prospect of euro area inflation staying too high for too long as a critical reason for the 0.25-percentage-point hike. However, it also suggested that it was keeping an open mind about future rate decisions and hinted that a pause in monetary tightening could be on the horizon.
Annual inflation in the euro area came in at 5.5% in June, down from 6.1% in May but still well above the ECB’s 2% target. Preliminary July inflation readings at a country level provided mixed messages. Data showed that price growth in France cooled more than expected to 5% in July from 5.3% in June. However, adjusted Spanish inflation came in at 2.1% in July, up from 1.6% in June and against expectations of another flat 1.6% print.
Lastly, Japan’s stock markets rose over the week, with the Nikkei 225 Index up 1.4% and the broader TOPIX Index gaining 1.3%. The Bank of Japan surprised investors by tweaking its monetary policy, announcing that it would increase flexibility around its yield curve control (YCC) target. As widely expected, the BoJ revised its forecast for consumer price inflation in fiscal 2023.
The yield on the 10-year Japanese government bond (JGB) rose to 0.55%, from 0.48% at the end of the previous week, to its highest level in around nine years on the BoJ’s monetary policy tweak and in anticipation of further normalization. The yen strengthened to around JPY 139.8 against the U.S. dollar from the prior week’s JPY 141.8.
Following its July 28–29 monetary policy meeting, the BoJ decided to keep its key short-term interest rate unchanged at -0.1% and that of 10-year JGB yields around zero percent. It judged that a sustainable and stable achievement of its 2% price stability target had not yet come in sight.
However, the central bank surprised investors with the announcement that it would conduct YCC with greater flexibility to enhance the sustainability of monetary easing under the current framework. While it will continue to allow, 10-year JGB yields to fluctuate in a range of around plus and minus 0.5% from the zero percent target level, greater flexibility means that it will regard the upper and lower bounds of the range as references, not as rigid limits, in its market operations. The BoJ will also offer to buy 10-year JGBs at 1.0% (changed from 0.5%) every business day through fixed-rate purchase operations.
THE WEEK AHEAD
This week investors will closely monitor the jobs report, ISM PMI surveys, and JOLTs' job openings. It is expected that non-farm payrolls will increase by 200 thousand in July, which would be the lowest figure since a decline was recorded in December 2020, indicating the potential effects of the unprecedented policy tightening delivered by the Fed in recent months. Additionally, the second-quarter earnings season will be in full swing, featuring reports from companies such as Apple Inc, Amazon.com, Advanced Micro Devices, Shopify, Alibaba Group, Uber Technologies, Merck & Co, Pfizer, Gilead Sciences, Moderna, Caterpillar Inc, Starbucks Corp, The Kraft Heinz Co, Etsy, PayPal Holdings, and Airbnb. In addition, investors will find interest in following the ADP employment change, second-quarter labor productivity and labor costs, factory orders, and regional industry indexes such as the Chicago PMI and Dallas Fed Manufacturing Index.
Have a great week.
Stephen Colavito
Chief Investment Officer
San Blas Securities
This message is informational and should not be construed as a solicitation or offer to buy or sell securities or other financial instruments. Past performance is not a guarantee of future results. San Blas Advisory is a registered investment adviser. More information about the firm can be found in its Form ADV Part 2, available upon request.