Can Stocks Shake Off Their 3-Week Losing Streak?
Materials (down 5% on the week) were driven lower by Industrial Metals and Chemical stocks, while Technology, also down 5.0% last week, was driven lower by weakness across semiconductors. U.S. officials notified key U.S. semiconductor companies, such as Nvidia and AMD, instructing them to stop sending specific high-end chips to China to hamper Beijing's development in areas such as Artificial Intelligence (AI). As a result, the Philadelphia SOX Index lost roughly 7.0% on the week and is down approximately 34% year-to-date, on track for its worst calendar year since 2009.
The more defensive properties of Utilities (down 1.6%) and Health Care (lower by 1.8%) helped weather some of the selling pressure last week, though Gold dropped 1.6% for its third consecutive week of declines. U.S. Treasury prices were weaker, with the curve steepening last week and the 10-year U.S. Treasury yield finishing at 3.20%. With the 2-year yield ending the week at 3.40%, the 2-year/10-year U.S. Treasury spread remained inverted by 20 basis points.
The U.S. Dollar Index rose +0.8% on the week, setting a new 20-year high and logging its fourth week of gains in the past five weeks. Simply, a stronger dollar makes U.S. imports more expensive for the rest of the world. Importantly, a strong dollar could erode U.S. multinational profits over time and when foreign earnings are translated back into U.S. dollars.
West Texas Intermediate (WTI) crude dropped 6.7% last week, settling below $90 per barrel. Possible demand destruction in China, with officials in Beijing deciding to lockdown Chengdu for COVID-19, weighed on energy prices last week. The lockdown affects over 21 million people, slows activity in an important manufacturing hub, and is the most extensive lockdown since officials crimped activity in Shanghai earlier this year. More broadly, WTI is down nearly 30% from its early March highs as global recession odds have increased. Here in the U.S., gasoline prices fell for the 12th straight week. Notably, the AAA national average price for regular unleaded gasoline stood at $3.79 per gallon heading into the Labor Day holiday weekend, down roughly 24% from the high recorded on June 14 when prices topped $5.00 per gallon. This week, OPEC+ announced they would cut production by 100K barrels per day in October to maintain price stability.
Markets priced in aggressive Federal Reserve rate moves through year-end
In our view, markets are becoming more sensitive to the terminal rate at which the Federal Reserve could hold its fed funds rate and when the central bank finally stops tightening rate policy. By the end of this year, the median market forecast provided by FactSet suggests the fed funds target rate could hit 3.75% - 4.00%, up from the current 2.25% - 2.50% level. But by June of next year, the CME FedWatch Tool points to a roughly 76% chance the fed funds rate will sit at 3.75% - 4.00% or below, meaning the majority of Fed rate increases during this cycle could come by year-end.
Bottom line: The market is currently priced for aggressive rate moves through year-end, with a subsequent slowdown in rate hikes and an eventual pause sometime in the first half of next year. However, on the edges, some estimates have the Fed cutting rates by June of next year, while other estimates suggest higher than consensus rates. And this is the rub for investors at the moment, which could keep stock prices sensitive to how market participants view incoming economic data and the ultimate path for Fed rate policy in the front half of 2023.
The labor market remains a key bright spot in U.S. economy
On the subject of incoming economic data, the August nonfarm payrolls report showed the labor market remains a key bright spot, contributing to a strong consumer backdrop and a still resilient U.S. economy. Last month, the U.S. economy added +315K new jobs, more than the +300K expected but down from the eye-popping +526K pace seen in July. In addition, the unemployment rate rose to 3.7% in August from 3.5% in July, driven by an increase in the labor force participation rate. In our view, this is a healthy sign for the employment backdrop, with more workers coming into the labor force to help fill the 11.2 million open positions as of July. Notably, average hourly earnings were softer than expected month-over-month in August, while the year-over-year wage growth rate matched July’s level at +5.2%. The Goldilocks employment report showed strong but softer labor trends, flattening wage inflation, more workers returning to the fold, and keeps the debate open on whether the Fed moves rates higher by 50 or 75 basis points at the end of the month.
Although the nonfarm payrolls report is backward-looking, there is little evidence today to suggest the labor market is moving meaningfully lower or is on a path to substantially rising unemployment. While other economic data continues to show signs of slowing, a tight labor market with unfilled positions running roughly 2 to 1 versus available workers could help support a healthy consumer backdrop in the months ahead and help stabilize the broader economy.
In other items of note during the previous week, August ISM manufacturing came in essentially flat month-over-month but better than consensus estimates and continues to sit in an expansionary condition. Prices paid within the report fell to June 2020 lows, another sign inflationary pressures are moderating. Finally, August consumer confidence rose for the first time in three months, with the “present situation” component in the report rising for the first time since March.
Central banks across the world take center stage this week
This week, the Federal Reserve will take a backseat to other major central banks, as the European Central Bank, Bank of Canada, and Reserve Bank of Australia hold policy meetings. According to a recent Bloomberg survey of economists, more than two-thirds of respondents believe the European Central Bank (ECB) has acted too slowly in battling inflation that hit +9.1% y/y on a headline basis last month. The majority of economists polled now see the ECB raising its key target rate by 75 basis points on September 8 and after moving by 50 basis points in July (more than the 25 basis points the ECB communicated prior to the decision). Many believe the ECB will now look through the potential for a near-term recession and raise rates more aggressively to stamp out record-high inflation in the Eurozone. A faster pace of ECB rate hikes could provide some support for the euro, which has fallen precipitously against the U.S. dollar this year, making U.S. imports more expensive for Europeans and adding to cost-of-living expenses. In addition, the Bank of Canada will deliver its rate decision on Wednesday after surprising markets with an outsized 100 basis point hike in July. Similarly, the Reserve Bank of Australia is likely to act aggressively this week, following 175 basis points worth of hikes since May and to unwind extraordinary monetary support.
In the UK, the Conservative Party unveiled that Liz Truss won the leadership contest and now replaces Boris Johnson as Prime Minister. Truss promised substantial tax cuts while campaigning but could raise tensions with the European Union over Northern Ireland protocols, increasing trade frictions when cost-of-living expenses have soared. However, Mrs. Truss will need to immediately address how her government plans to help tackle the ongoing energy crisis in the UK and where consumers could face spiraling energy charges as soon as next month.
Here in the U.S., the shortened Labor Day trading week will likely focus on a batch of Fed speakers that could further stoke the debate over a 50 or 75 basis point hike, with Fed Chair Powell speaking at a monetary policy conference on Thursday. In addition, Vice Chair Lael Brainard and Fed Governors Christopher Waller, Esther George, Charles Evans, and Michael Barr, also deliver speeches during the week. Lastly, the August ISM nonmanufacturing report on Tuesday should be the economic highlight of the week, with services activity expected to fall versus July levels but remain in expansion. Final August Purchasing Manager’s Index (PMI) reports, as well as initial jobless claims, will also be closely watched ahead of next week’s August Consumer Price Index (CPI) and Producer Price Index (PPI) reports.
Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.
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The CME FedWatch Tool analyzes the probability of FOMC rate moves for upcoming meetings. Using 30-Day Fed Fund futures pricing data, which have long been relied upon to express the market’s views on the likelihood of changes in U.S. monetary policy, the tool visualizes both current and historical probabilities of various FOMC rate change outcomes for a given meeting date. The tool also shows the Fed’s “Dot Plot,” which reflects FOMC members’ expectations for the Fed target rate over time.
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The Purchasing Managers’ Index™ (PMI™) is a composite index based on five of the individual indexes with the following weights: New Orders - 0.3, Output - 0.25, Employment - 0.2, Suppliers’ Delivery Times - 0.15, Stock of Items Purchased - 0.1, with the Delivery Times index inverted so that it moves in a comparable direction.
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