Last Week in Review – September 4, 2023 – from Stephen Colavito
Hopeful signs on the inflation front helped the major benchmarks end last week with solid gains, although stocks closed out their first negative month since February. Decreased longer-term interest rates over the week boosted growth shares, mainly by reducing the implied discount on future earnings. Smaller-cap stocks outperformed, however, narrowing the significant year-to-date gap with large-caps.
Trading volumes picked up around month-end, but traders noted that market activity remained generally muted as the summer vacation season ended. Markets were scheduled to be closed today during the Labor Day holiday.
As many observers noted, last week appeared to be one in which bad news for the economy was considered good news for stock prices, given the interest rate implications. On Tuesday, the S&P 500 Index recorded its best one-day gain since June, following news that job openings unexpectedly fell by 338,000 in July and hit their lowest level since March 2001. Job quits, considered by some to be a more reliable indicator of the strength of the labor market, also fell considerably.
US - MARKETS & ECONOMY
Last Friday’s closely watched nonfarm payrolls report appeared to confirm loosening labor market conditions. The Labor Department reported that employers added 187,000 jobs in August, somewhat above consensus expectations, but gains for the previous two months were revised lower by a combined 110,000. Average hourly earnings also rose by only 0.2% for the month, a tick below expectations. Most notably, perhaps, the unemployment rate climbed from 3.5% to 3.8% to reach its highest point since February 2022. As 736,000 people reentered the job market, the labor force participation rate hit 62.8%, its highest level since the pandemic's start in February 2020.
Even as the labor market slowed, hopes appeared to grow that the economy would escape a substantial slowdown in 2023—the so-called no-landing scenario. On Thursday, the Commerce Department reported that personal spending jumped 0.8% in July, above expectations and well above a 0.2% increase in consumer prices during the month. On Friday, the Institute for Supply Management reported that its gauge of manufacturing activity—although still indicating a contraction in the sector—climbed unexpectedly to its best level since February. A gauge of overall business activity in the Chicago region also surprised on the upside.
Atlanta Federal Reserve Bank President Raphael Bostic appeared to boost sentiment on Thursday, telling a conference in South Africa that he believed the current level of interest rates was “appropriately restrictive” and on track to bring down the inflation rate to the Fed’s target of around 2.0%. Along with the inflation and jobs data, his comments seemed to bolster hopes that the Fed would forgo another rate increase this year. The probability the Fed would remain on hold for the rest of the year, as measured by the CME FedWatch tool, rose considerably over the week, from 44.5% to 59.8%.
US YIELDS & BONDS
While short-term Treasury yields decreased considerably over the week, the benchmark 10-year U.S. Treasury note yield increased sharply on Friday morning, leaving it modestly lower for the week. (Bond prices and yields move in opposite directions.) Overall, it was a quiet week in the fixed-income market, with no primary issues in the corporate bond markets and generally light trading activity.
US TREASURY MARKETS – CURRENT RATE AND WEEKLY CHANGE
3 Mth -0.04 bps to 5.41%
2-yr: -0.20 bps to 4.88%
5-yr: -0.14 bps to 4.30%
10-yr: -0.06 bps to 4.18%
30-yr: +0.01 bps to 4.29%
INTERESTING NEWS OVERSEAS
In local currency terms, the pan-European STOXX Europe 600 Index ended 1.49% higher on hopes that interest rates would soon peak and that a recession, while possible, would likely prove to be shallow and short-lived. Stocks also appeared to receive a lift from China’s efforts to bolster its economy. Major stock indexes in France, Germany, Italy, and the UK also advanced.
European government bond yields edged lower last week as core inflation data and comments from policymakers suggested that the European Central Bank (ECB) could be nearing the end of its monetary policy tightening cycle. The yields on 10-year government bonds issued by France and Germany ticked lower. Softer economic data pushed the yield on UK 10-year sovereign bonds near one-month lows.
The annual inflation rate in the eurozone was steady at 5.3% in August, according to a preliminary estimate from Eurostat, the European Union’s official statistical office. The result was slightly higher than the 5.1% expected by economists polled by FactSet. The core inflation rate, a measure of underlying price pressures that filters out volatile food and energy costs, slowed in line with expectations, coming in at 5.3%—a 20-basis-point improvement from July. (A basis point is 0.01 percentage point.)
The minutes from the ECB’s July meeting called out the strong labor market in the euro area and suggested that a soft landing might be possible for the slowing eurozone economy. The seasonally adjusted unemployment rate stayed at a record low of 6.4% in July, matching a consensus forecast.
Japan’s stock markets gained over the week, with the Nikkei 225 Index rising 3.4% and the broader TOPIX Index up 3.7%. Some weaker-than-forecast U.S. economic data releases boosted expectations that the U.S. Federal Reserve was getting closer to halting its interest rate hiking cycle, supporting sentiment. Investors also welcomed China’s latest measures to boost its markets and economy.
The yield on the 10-year Japanese government bond fell to 0.63% from 0.64% at the end of the previous week. The Bank of Japan (BoJ) announced that it would conduct bond-buying operations one day before its auction of 10-year notes in the week beginning September 4, which weighed on yields.
While the yen strengthened to around JPY 145.4 against the U.S. dollar, from about JPY 146.4 the prior week, its historic weakness continued to stoke speculation that Japan’s monetary authorities could intervene in the foreign exchange markets to prop up the currency.
Seeking to alleviate the effects of high fuel costs on households and businesses, Japan’s government pledged measures to ease record-high gasoline prices and to extend its subsidy program for oil wholesalers beyond September until the end of the year.
While the weak yen has pushed up gas prices, the government’s subsidies have helped keep overall inflation levels down, supporting the case for the BoJ to maintain its accommodative stance. BoJ Board member Toyoaki Nakamura reiterated that monetary easing needs to be persistently maintained in pursuit of the central bank’s inflation target and that any policy pivot will take time.
Lastly, Chinese stocks rose after the government issued stimulus measures to revive the economy. The blue-chip CSI 300 Index and Shanghai Composite Index advanced for the week. In Hong Kong, the benchmark Hang Seng Index rose for the week ended Thursday after financial markets were closed Friday due to the approach of a typhoon.
The previous Friday, China’s central bank cut the amount of foreign currency deposits that domestic banks must hold as reserves. The reduction in the foreign exchange reserve requirement ratio from 6.0% to 4.0% effectively freed up more foreign currency in the local market to buy the renminbi currency, which fell to its lowest level since 2007 against the U.S. dollar in August. The central bank’s move came hours after China’s financial regulator said it would reduce minimum down payments for homebuyers nationwide and encouraged lenders to lower rates on existing mortgages.
The raft of policy announcements signaled Beijing’s growing concern about the economy, which has been losing momentum this year. Disappointing data, deflationary pressures, record youth unemployment, and a deepening slump in the debt-laden property sector have fueled an erosion of confidence in China’s economy.
THE WEEK AHEAD
US markets will be closed on Monday in celebration of Labor Day. Later in the week, investors will anticipate the release of the ISM Non-manufacturing PMI survey, which will likely signal a modest deceleration in the country's service sector. Alongside this, the US is releasing various other important economic indicators, including factory orders, foreign trade, IBD/TIPP Economic Optimism, weekly jobless claims, and the final readings of the S&P Global Services PMI and second-quarter labor productivity. Elsewhere in America, the Bank of Canada will likely hold interest rates at current levels as policymakers adopt a wait-and-see approach to observe the effects of the latest cumulative policy tightening on price pressures and activity. The country's employment report, Ivey PMI, and trade balance will also be in the spotlight, as well as Mexico's inflation and consumer morale, Brazil's industrial output, and S&P Global Services PMI.
Have a great week.
Stephen Colavito
Chief Investment Officer
San Blas Securities
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