To What Extent Can Policy Changes Impact Slowing Economic Growth?

Fear of a worsening global economic slowdown dragged bond yields sharply lower last week. The yield on the ten-year Treasury note plunged 20 basis points to 1.55 percent (a basis point is 1/100th of a percent), briefly causing an inversion of the yield curve between the two and ten-year maturities. Since the administration’s Aug. 1 announcement of another possible round of 10 percent tariffs on Chinese imports, the yield has collapsed by an extraordinary 46 basis points. Also last week, the yield on the thirty-year bond fell to an all-time low of 1.97 percent, down from 2.53 percent at the beginning of the month.

Trade Uncertainty Causing Daily Volatility

Stocks fell for the second straight week, although they finished well off their lows. The S&P 500 fell 0.5 percent, but that was a relative victory after the index fell 3 percent on Monday. Fears of a debilitating currency war with China was the catalyst for the initial decline after the yuan broke through the psychologically important level of 7 to the dollar. But those fears receded after the currency stabilized. 

Investors Have Mostly Ignored the Trade War … Until Now

President Trump turned up the heat in the trade war with China and stocks reacted badly. The S&P 500 had stumbled modestly following Fed Chairman Powell’s post-meeting news conference on Wednesday, but by the middle of the following day had recovered all of that lost ground. It was then that the president announced his intention to impose a 10 percent tariff on the remaining $300 billion of Chinese exports to the U.S. that had to date been exempt, precipitating a 2.5 percent selloff in the index into the close on Friday. In total, the S&P 500 was down 3.1 percent for the week. 

Are Investors Being Set Up for Disappointment?

Equity investors welcomed the advance estimate of second quarter U.S. GDP that showed the expansion remained on track but was not likely strong enough to dissuade the Federal Reserve from cutting interest rates this week. The 2.1 percent annualized growth rate was well down from the unrevised 3.1 percent pace of the first quarter, but nevertheless exceeded the consensus forecast of 1.8 percent. The components of the report reflected the larger forces currently affecting the economy.


This Week Could Be a Turning Point for Markets

The start to earnings season wasn’t strong enough to keep stocks in record territory. The major banks, by and large, exceeded tempered expectations, but results for the group overall were mixed. Strength in consumer activity was offset, in some cases, by softness in business activity and trading. And the prospect of one or more cuts by the Federal Reserve pressured the outlook for net interest margins. For the week, the BKX bank index slipped 0.3 percent, contributing to the decline of 1.3 percent in the financial sector. But the S&P 500 overall shed 1.2 percent, as financials had plenty of company on the downside. Only materials and consumer staples managed fractional gains, while every other sector finished lower. That included energy stocks, which fell 2.6 percent despite rising tensions in the Persian Gulf.