Equity Indices Soar And Investors Flock To Treasuries?

Robust economic data, strong corporate earnings, and record highs reached by three major equity indices should have triggered a selloff in U.S. Treasuries (thereby promoting higher yields). However, treasuries treasury yield stubbornly remained below the key 3% level. Trade tensions coupled with troubled emerging markets (such as Turkey and Argentina), a slowdown in growth outside the U.S. (particularly in China), continues to have investors flock towards safe-haven assets, such as U.S. Treasuries. Ten-year Treasury yields closed the week at 2.816%. Oil headed for its first weekly rise in almost two months with Brent crude trading around $75.82 on Friday.

Some economists argue that there is an increased likelihood of a turning point in the economic cycle in the next 6-12 months and may be in part why long-term yields remain stubbornly low. In addition to the escalating trade tensions, the increasingly dramatic U.S. political landscape, declining U.S. housing sales, and what may be peaked manufacturing output (see below), the impact of the fiscal stimulus and tax cuts are expected to wane by next year. 

Fed Chair Jerome Powell noted last week that while the Fed keeps a wary eye on inflation and unemployment levels, it also monitors excesses in the economy that may cause another recession. For now, low unemployment rates and moderate inflation (data to be released this week) keeps the Fed on a gradual tightening path.

I. U.S. Economic Data/Markets

• FOMC Minutes from the Fed’s July meeting indicated the likelihood of the Fed hiking rates again next month. The minutes reflected potential concerns, which included:
  • Rising trade disputes and the impact on economic growth, that could reduce the purchasing power of households, and hamper business investment, sentiment and hiring. Trade disputes may serve as “an important source of uncertainty and risks,” according to the minutes.
  • A weakening housing market.
  • Rising oil prices.
  • A slowdown in emerging markets.

• U.S. PMI came in lower-than-expected, indicating that private sector output growth lost its momentum in August. The composite PMI was 55 in August versus 55.7 in July. August Manufacturing PMI at 54.5, a nine-month low, was also weaker than July’s reading of 55.3. The Manufacturing Output Index was at an 11-month low, at 54.3 from 54.5 in July.
• Housing price index – U.S. housing prices rose at its slowest pace in four years. However, prices rose 1.1% in the second quarter, which is up 6.5% from 2Q 2017 to 2Q 2018.
• The S&P 500 closed the week at an all-time high as it continued the longest bull run in history. The Nasdaq Composite (7,945.98) and Russell 2000 (1,725.67) also closed at all-time highs. 
  • A healthy economic backdrop coupled with strong corporate earnings and moreover Fed Chair Powell’s speech on Friday prompted the S&P 500 to close at 2874.69, overshadowing the high reached on January 26. 
  • The S&P 500 turned 3,453 days old mid-week – the longest bull market run. 
  • The index gained roughly 320% since the market bottomed more than nine years ago.
  • Some market practitioners believed the S&P 500 is overvalued as it traded about 18 times projected earnings for the current financial year, above the ten-year average.
• At the annual Jackson Hole economic symposium, Fed Chair Jerome Powell reaffirmed the Fed’s current path to hiking rates until economic data suggests otherwise.
  • The market is largely expecting the Fed to hike at its meeting next month and then again in December.
  • Powell noted two historical periods that guide the Fed’s current thinking: inflation levels in the 1970s and the economic expansion in the mid-1990s.
  • Uncertainty lingered as to why inflation has been relatively low given the low levels of unemployment.
  • Outside of inflationary pressures, with the financial crisis of 2008 in recent memory, the Fed monitors any excesses that may destabilize the economy.
  • Stocks edged higher and bond yields lower on Friday on the back of Powell’s sentiments.

II. Other

• U.S. Pension Plans take a bite out of the Commercial Real Estate lending market.
  • The California State Teachers’ Retirement System, which has about $29 billion invested in real estate, announced committing up to $500 million to a new real-estate debt firm called 3650 REIT.
  • The move signaled to some that the bull market in real estate may be nearing its end as lending seems to be a “safer investment” in lieu of equity allocations in RE.
  • Lending by traditional banks have not been as robust post-crisis as non-traditional lenders have filled the role the banks once served.
• Trade Talk
  • Levies were applied to an additional $16 billion of Chinese goods on Thursday, as U.S. and Chinese officials failed to reach an agreement after meeting last week. The latest levies bring the total tariffs imposed by the U.S. to about $50 billion on Chinese goods. Another $200 billion could be imposed next month, which represents nearly half of Chinese exports. 
    • Products impacted by the latest tariffs included: semiconductors, chemicals, plastics, motorbikes and electric scooters.
    • China retaliated with new tariffs on $16 billion worth of U.S. goods, that included fuel, steel products, autos and medical equipment.
• Mexico and the U.S took one step closer in resolving remaining bilateral issues in related to the revamp of the NAFTA trade deal, although details of the negotiation have yet to be disclosed.
• German Q2 GDP data reflected strong growth in the EU’s largest economy driving the Euro higher on Friday. Government spending, consumption, and investments primarily drove growth resulting in a Q2 reading of a 0.5%.

This week:

Domestically, the market will be focused on the Q2 GDP data and core personal expenditures as this is the inflation gauge the Fed tracks. While a wide variety of key data is expected to be released abroad, a decent proportion of the data points are housing related. 

Key data/events include:
GBP Inflation report hearings (Tuesday)
U.S. S&P/Case-Shiller home price indices (Tuesday) 
AUD HIA New Home Sales (Wednesday)
German GfK consumer confidence survey (Wednesday)
U.S. Q2 GDP (Wednesday)
U.S. Core personal consumption expenditures QoQ (Wednesday)
JPY retail trade data (Wednesday)
German unemployment data (Thursday)
GBP mortgage approvals (Thursday)
U.S. Core personal consumption expenditures YoY (Thursday)
German Harmonized Index of consumer prices (Thursday)
JPY CPI data (Thursday)
EUR CPI/unemployment data (Friday)

U.S. Economic Data includes: Dallas Fed manufacturing index (Monday), Chicago Fed National Activity Index, wholesale inventories (Tuesday), Redbook index, S&P/Case-Shiller home price indices, Richmond Fed Manufacturing Index, U.S. Q2 GDP (Wednesday), core personal consumption expenditures, pending home sales, U.S. core personal consumption expenditures YoY (Thursday), weekly jobless claims, July personal income data, Chicago PMI (Friday), Michigan consumer sentiment, Baker Hughes U.S. oil rig count.

Overseas Economic Data includes: German IFO: business climate/current assessment/expectations (Monday), GBP inflation report hearings (Tuesday), French/Italian confidence data, Swiss employment data, Italian PPI, AUD HIA New Home Sales (Wednesday), JPY consumer confidence index, German GfK consumer confidence survey, French consumer spending/GDP, Swiss ZEW survey, CAD current account, NZD building permits, JPY retail trade, JPY foreign bond/stock investments, AUD building permits (Thursday), German unemployment data, GBP mortgage approvals, EUR business climate, German Harmonized Index of consumer prices, CAD GDP, GBP Gfk consumer confidence, JPY CPI data, JPY unemployment rate, CNY PMI data (Friday), German retail sales, French CPI, EUR/Italian unemployment data, EUR CPI data, Italian GDP.