HIGHLIGHTS:
Stocks finished lower on mixed trade news.
Consumer economic fundamentals are positive. Other data more uneven.
The Fed and the markets remain at odds over interest rates.
Week Ahead: Focus on trade again.
Stocks finish lower on mixed trade news.
We were taught not to run with scissors, because we may stumble and hurt ourselves. It seems policymakers are running with scissors, and it sent investors to the perceived safety of Treasury bonds in the latest week. First, trade negotiators for the U.S. and China backed away from recent progress and China appears to be putting stakes in the ground that will make a trade deal more difficult. We talked about that in latest week’s commentary. On the positive side, the U.S. decided to defuse tensions with the EU by delaying a decision on auto tariffs and lifted steel and aluminum tariffs on Canada and Mexico, easing the path for passage of the USMCA trade deal. Second, Federal Reserve officials remained stuck in neutral regarding interest rates, but market participants, including Via Nova, believe a rate cut prior to yearend is warranted given the current global uncertainty. Policymakers are running with scissors but have not fallen… yet.
The S&P 500 finished down a bit over half percent for the week, selling off on China trade news and rallying on EU and USMCA developments. The more defensive utility and staples sectors outperformed as would be expected in a nervous market. The risk-off sentiment reflecting a defensive stance weighed more heavily on small caps which lagged the S&P 500, but most of the selling pressure hit emerging markets again, which fell over -3½% after losing -4 ½% the prior week. Developed international markets, including the EU, rose on news that a decision on auto tariffs will be delayed at least six months.
Bonds benefited from the uncertainty once again, and the odds that the Federal Reserve may decide to lower short term rates increased. The yield on the 10-year Treasury note fell to 2.39%, which allowed further declines in home mortgage rates and lifted the Merrill Lynch Broad Bond Market Index by another 0.3%.
Other markets were generally positive amid the turmoil. Real Estate Investment Trusts (REITS), Treasury Inflation-Protected Securities (TIPS) and oil rose, but gold prices slipped. The value of the dollar increased, a safe haven amidst global uncertainty.
Consumer economic fundamentals are positive. Other data more uneven.
The latest round of economic reports showed a healthy labor market, and consumer sentiment rose to a 15-year high. Retail sales disappointed in April, but we believe the underlying fundamentals of a strong job market and rising wages will provide sufficient support to keep consumer spending at a high level. April industrial output slipped, but a May survey of business activity from the Philadelphia Federal Reserve showed improving momentum. The U.S. economy and the U.S. consumer in particular, are islands of strength in an otherwise sluggish global economy.
The Fed and the markets remain at odds over interest rates.
The back-and-forth of trade negotiations is well documented, but a potentially looming obstacle is the current level of short-term interest rates, which are set by the Federal Reserve. Short term rates and 10-year Treasury yields are nearly equal, which runs counter to theory, history and common sense. Investors should, and historically have, required higher yields to compensate for the increased risk of longer-term loans. We believe the Federal Reserve may have raised rates too far in 2018 in their quest to “normalize” monetary policy. While the markets are pricing in a Fed rate cut later this year and a return to a more normal interest rate structure, Fed officials point to the need to be vigilant against rising inflation and to build “dry powder” to cut rates if and when the economy falters. We believe the Fed will ultimately lower rates, but the process to shift current thinking could be arduous and lengthy.
Week Ahead: Focus on trade again.
Trade news will again be the primary focus in the coming week.Markets will likely bounce from one tweet and rumor to the next.Home sales for April are due on the economic calendar and are expected to benefit from the recent decline in mortgage rates.New orders for durable goods are also due.