HIGHLIGHTS:
- The latest battle between facts and fears ended in a draw.
- Healthy retail sales and improving manufacturing sentiment lifted second quarter growth estimates.
- The FOMC lifted the federal funds rate by a quarter percent, as expected, citing economic strength.
- Trade tariffs now more reality than fear, but still very much short of a trade “war.”
- North Korea Summit was a start, but not a market mover.
- Coming Week: Housing data will be the focus in the coming week along with the Philadelphia Fed business survey. OPEC meets.
The latest battle between facts and fears ended in a draw.
Stronger economic reports were mostly offset by the decision to impose tariffs on our major trading partners and the possibility of more aggressive Federal Reserve interest rate increases. The S&P 500 finished the week nearly flat (+0.07%), as consumer stock gains were countered by weakness in energy and financial stocks. Small cap stocks outperformed the S&P, while international and emerging market stocks fell.
The yield on the 10-year Treasury note held steady for the week, though yields on shorter maturity bonds rose. However, the healthier economic data helped narrow credit spreads making it somewhat cheaper for corporate borrowers.
Oil prices remained under downward pressure, due to planned production increases by Saudi Arabia and Russia to offset production losses in other countries. Gold prices also fell, while the value of the dollar rose a hefty 1.33% in the latest week.
Healthy retail sales and improving manufacturing sentiment lifted second quarter growth estimates.
Retail sales in May rose by 0.8%, a higher than expected number, thus accelerating the annualized 3-month growth in consumer spending to an impressive 7.9%. A healthy job market and improved consumer confidence were cited for this strength in sales. On the business side, the Empire Manufacturing Survey, conducted by the Federal Reserve Bank of New York, also rose more than expected. The strength in the week’s economic reports lifted the Atlanta Fed’s second quarter GDPNow growth estimate to an impressive 4.8% annual rate, well above the 2.2% growth in the first quarter. Stronger growth suggests higher profits and investment – all good for stock values.
The FOMC lifted the federal funds rate by a quarter percent, as expected, citing economic strength.
The Federal Open Market Committee (FOMC) met and decided to raise the overnight federal funds rate by one quarter percent to a range of 1.75%-2%...as expected. The market focus was on Chairman Powell’s press conference remarks and the forecasts of the individual committee members, called the “dot plot.”
Powell cited a healthy economy as a reason that the FOMC was raising interest rates and would likely continue doing so in the future. Importantly, the individual forecasts suggest FOMC members are thinking hard about whether to raise rates two more times this year instead of one. Eight favored twice more and seven favored once. While that is very close, the message is that the Fed is comfortable raising interest rates, which will be a headwind to bond performance.
The European Central Bank (ECB) also met but offered more guidance than action. The ECB announced plans to wind down the bond purchase program by the end of the year but plans to maintain below zero rates until the summer of 2019. As the ECB joins the Fed in raising interest rates next year, upward pressure on bond yields will likely increase, depressing bond returns. Also, higher U.S. rates relative to the rest of the world tends to increase the value of the dollar, which is up 3.22% so far this year.
Trade tariffs now more reality than fear, but still very much short of a trade “war.”
President Trump announced the imposition of modest trade tariffs on China and our key trading partners, after little progress in negotiations. The market and economic risk is that this move will not be the last move, and that we might see an escalating tit-for-tat resulting in a trade war. How did the markets react? The S&P 500 finished nearly flat on Friday, but major exporters that dominate the Dow Jones Industrial Average fell. The apparent market indifference suggests to us and the markets that these tariffs are not yet a return of Smoot-Hawley trade isolation but rather the latest negotiating tactic by President Trump.
While the risk of a trade war has increased, our most likely scenario is that it will be avoided. We will continue to monitor developments closely.
North Korea Summit was a start, but not a market mover.
The meeting between President Trump and Kim Jong Un was also met with a shrug by U.S. stock index futures as the two leaders signed a "comprehensive" and "historic" document that included the following four points:
- Establishing new US-DPRK relations,
- Building a lasting and stable peace regime,
- Reaffirming commitments to work toward complete denuclearization and
- Recovering POW/MIA remains.
If the above list sounds vague, it is. The meeting is seen as the beginning of a long process, which could be derailed by either side at any time. U.S. sanctions will remain in effect for the time being and American forces will not be reduced on the Korean peninsula. While the world would welcome lasting peace on the Korean peninsula, any economic and market impact would be far in the future.
Coming Week: Trade and housing data will be the focus in the coming week along with the Philadelphia Fed business survey. OPEC meets.
The market will be on the lookout for further announcements related to trade. Good news (negotiations) or bad news (escalation) could be a significant market mover. On the economic front, housing data and the Philadelphia Fed Survey will dominate. As a reminder, the composition of the Philly Fed survey is closer to that of the national average, and so is an early indication of June manufacturing activity. Finally, OPEC meets in Vienna to discuss raising oil production, now that prices are up 46% over the past year. Oil prices have already fallen in anticipation of the news.