Markets React to a Week Full of Surprises
The second surprise came from the Federal Reserve, where Vice Chair Stanley Fischer announced his retirement, effective mid-October, well ahead of his term expiration next June. The move creates another vacancy on the seven-person board of governors where there were already three. The President’s nominee for one of those seats, Randal Quarles, moved one step closer to confirmation as the Senate Banking Committee confirmed him to the full Senate for a vote. But Fischer’s resignation certainly gives the President the opportunity to reshape the Federal Reserve. What that might mean for monetary policy is unclear.
The likelihood of another rate hike continued to diminish when Governor Brainard said the Fed might need to slow down given the recent low inflation readings. Already in a downtrend, the yield on the ten-year treasury note plunged 11 basis points to 2.06 percent following those comments on Tuesday, before ending the week at 2.05 percent, the lowest rate since the election. The dollar continued its slide as well. Contributing to the downside pressure was the European Central Bank’s (ECB) meeting on Thursday when it left policy unchanged. But it did indicate a decision at its October meeting about what it intends to do with its quantitative easing program, which is set to expire at year end. The euro added to its recent strength following President Draghi’s press conference.
The Economic Impact of Hurricane Relief and Recovery
Included in the three-month extension of the debt ceiling and continuing resolution was funding to assist with the damage from Hurricane Harvey. And just as the recovery from Harvey has begun, Hurricane Irma came barreling toward the Caribbean and mainland U.S. The total combined rebuilding effort, including damage done to other countries in the Caribbean, is estimated to cost upwards of $500 billion, although some early reports indicate that the damage from Irma may be less than initially feared. The U.S. economy will certainly be dented by the interruption in activity, before it benefits from spending on the recovery effort. But the broken window fallacy suggests there is no net benefit to the economy.
Whether and how much the drop in both stock prices and bond yields is attributable to policy uncertainty, geopolitical concerns, or worries about economic growth is difficult to determine. The spread between short and long-term bond yields has compressed steadily since late December when the difference between two and ten-year note yields was 136 basis points. After widening briefly following the French elections in June, the spread has continued to tighten, ending last week down another five basis points at 77, close to the narrowest in a year. And while that is a long way from being inverted, a classic harbinger of recession, it nevertheless has some wondering whether it is signaling weakness ahead.
S&P Modestly Down While Certain Sectors Suffer Greater Declines
On the week, the S&P 500 lost a modest 0.6 percent. But several sectors suffered far steeper declines. Telecom stocks fell more than 3.5 percent following downbeat comments at an industry conference, followed by financials, which suffered as bond yields tumbled. Benefitting from the same phenomenon, utilities, REITs and staples all rose. Healthcare led the gainers, followed by energy as refiners shut down by Harvey began to restart.
There was only faint evidence of a move to safety in the high yield bond market. The yield to maturity of the Bank of America Merrill Lynch High Yield Master II index was virtually unchanged last week. And although its spread versus treasuries rose slightly last week, it has been relatively stable over the last month.
This week’s economic calendar includes August consumer prices and retail sales, industrial production and consumer sentiment. Obviously for the Fed the Consumer Price Index (CPI) report on Thursday is the most important. The headline rate is expected to edge higher, while the core rate is expected to edge fractionally lower. Apple is also expected to introduce the iPhone 8 on Tuesday.
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The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
The Consumer Price Index is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. Changes in CPI are used to assess price changes associated with the cost of living.
Indexes are unmanaged and are not available for direct investment.
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