Last Week in Review – September 25, 2023 – from Stephen Colavito
The major U.S. equity benchmarks declined for the week as investors reacted to hawkish forecasts from the Federal Reserve’s meeting last week and rising U.S. Treasury yields. The S&P 500 Index recorded its largest one-day loss in six months on Thursday on its way to a third-straight losing week.
In addition to concerns about higher interest rates, worries about the impact of the United Auto Workers’ strike and the potential for a U.S. government shutdown may have also weighed on markets. Meanwhile, tax-loss harvesting could have exacerbated selling as fiscal year-end approached for some investors.
US - MARKETS & ECONOMY
As expected, the Fed left its short-term lending benchmark at a target range of 5.25% to 5.50%, the level set at the previous meeting in July, and its updated Summary of Economic Predictions continued to show one more rate hike in 2023. However, policymakers surprised markets with an outlook for rates in 2024 that was notably higher than expected, and their rate prediction for 2025 also increased. In addition, the central bank raised its growth forecast, acknowledging that the economy has been more resilient than expected.
Apart from the Fed meeting, it was a relatively light week for economic news. Weekly initial jobless claims came in lower than predicted and fell to the lowest level since January, further reinforcing views that the labor market remains strong.
US YIELDS & BONDS
The prospect of the Fed keeping short-term rates higher for longer, along with healthy economic growth signals, helped send longer-term U.S. Treasury yields higher, with the benchmark 10-year U.S. Treasury yield reaching a 16-year high. (Bond prices and yields move in opposite directions.) Yields on AAA-rated municipal bonds moved sharply higher alongside weakness in the Treasury market as investors priced in a higher rate regime.
In the investment-grade corporate bond market, yield premiums relative to Treasuries remained relatively stable despite the risk-off environment in the equity market. Meanwhile, the primary market for high-yield bonds remained busy, and more deals are expected amid solid demand for new issues.
US TREASURY MARKETS – CURRENT RATE AND WEEKLY CHANGE
3 Mth +0.02 bps to 5.47%
2-yr: +0.08 bps to 5.11%
5-yr: +0.10 bps to 4.56%
10-yr: +0.10 bps to 4.43%
30-yr: +0.10 bps to 4.52%
INTERESTING NEWS OVERSEAS
The pan-European STOXX Europe 600 Index ended 1.98% lower as central banks signaled that interest rates will stay high for some time. Higher oil prices and poor business activity data also clouded the economic outlook. Major country stock indexes also fell. France’s CAC 40 declined 2.67%, Germany’s DAX lost 2.26%, and Italy’s FTSE MIB slipped 1.13%. The UK’s FTSE 100 was little changed in local currency terms, supported by a depreciation of the UK pound versus the U.S. dollar. A weaker UK currency helps to bolster the index, which includes many multinationals with overseas revenues.
Eurozone government bond yields increased after European Central Bank (ECB) officials said another interest rate increase could not be ruled out and after the Fed indicated that rates will likely remain higher for longer. However, the move moderated later in the week after a surprise decision by the Bank of England (BoE) to keep short-term interest rates on hold and weak eurozone PMI data. UK gilt yields decreased, with more notable moves at the shorter-maturity end of the yield curve.
The BoE’s Monetary Policy Committee voted 5-4 to keep the key interest rate unchanged at 5.25% as economic growth slows—the first pause since December 2021. BoE Governor Andrew Bailey stressed that borrowing costs could rise again if there is evidence of more persistent inflationary pressures.
The decision to halt policy tightening came a day after official data showed that annual inflation in the UK slowed to 6.7% in August from 6.8% in July. The underlying inflationary pressures declined but remained well above the BoE’s 2% target.
Japan’s stock markets fell over the week, with the Nikkei Index down 3.4% and the broader TOPIX declining 2.2%. The sentiment was dampened by the U.S. Federal Reserve signaling that it planned to keep interest rates higher for longer to combat persistent inflation. In contrast, the Bank of Japan (BoJ) matched expectations of no change to its monetary policy, dashing hopes that the central bank would hint at an exit from negative interest rates.
Continued monetary policy divergence between the hawkish Fed and the dovish BoJ weighed on the yen, which weakened to around JPY 148.3 against the US dollar from about JPY 147.8 the previous week. As speculation about potential intervention in the foreign exchange markets to prop up the yen continued, Finance Minister Shunichi Suzuki said that the government would respond to excessive currency volatility without ruling out any options. In his view, the operations last year to buy yen and sell the U.S. dollar had been effective, to a certain degree.
Lastly, Chinese equities rose as investors grew more optimistic about the country’s economic outlook. The Shanghai Composite Index gained 0.47%, while the blue-chip CSI 300 Index added 0.81%. According to FactSet, Hong Kong's benchmark Hang Seng Index declined 0.7%.
No major indicators were released in China during the week. However, official data for August released the prior week provided evidence of economic stabilization in the country. Industrial production, retail sales, and lending activity rose more than forecast last month from a year earlier. However, fixed-asset investment grew less than expected as property investment dropped.
Last Thursday, state media reported that China's cabinet, the State Council, pledged to accelerate measures to consolidate the country’s recovery and continue supporting growth in 2024. Senior officials acknowledged that while China faces economic challenges, historical trends suggest that the economy is set to improve over the long term. In a sign of investors’ concern about the health of China’s economy, China recorded capital outflows of USD 49 billion in August, the largest since December 2015, which pushed the yuan to a 16-year low against the U.S. dollar, according to Bloomberg. In response to the deteriorating growth signals, Beijing issued a flurry of pro-growth measures in recent weeks aimed at stimulating consumption and reviving the moribund property market.
THE WEEK AHEAD
Next week, all eyes will be focused on the US personal outlays and income report, with particular anticipation surrounding the release of the PCE price index. It is expected that core PCE prices have risen by 0.2% in August, the same pace as in July, while the annual rate, which is considered the Federal Reserve's preferred gauge of inflation, is expected to have eased to 3.8%, marking its lowest point since June 2021. The report is also poised to reveal a 0.5% increase in consumer spending and a 0.4% gain in income for the same period. In addition, investors will closely monitor August's durable goods orders, the final readings on second-quarter GDP growth, and September's Michigan consumer sentiment. Moreover, the housing market will come under scrutiny, focusing on Case-Shiller home prices new and pending home sales figures. Additionally, market watchers will closely monitor advance estimates of wholesale inventories, the goods trade balance, CB consumer confidence, the Chicago Fed National Activity Index, and the Dallas Fed Manufacturing Index.
Have a great week.
Stephen Colavito
Chief Investment Officer
San Blas Securities
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