Last week the world began to sift through the aftermath and implications of the terror attacks in Israel which, beyond the horrific human toll, sent shock waves through global geopolitics and financial markets, beginning with interest rates and the oil sector. Global equity markets remained relatively calm with the S&P 500 up 0.46% and developed and emerging equity markets both relatively flat. The bigger moves on the week were in areas you might expect including oil (+6%), gold (+5%), and safe haven USD (+0.57%) and treasury bonds which saw yields decline across the curve and by double digits for longer maturities.

• Aside from the obvious human tragedy, the peculiar timing of the Hamas incursion into Israel last weekend has injected tangible uncertainty into global energy markets and geopolitical anxiety regarding the potential for escalation in the Middle East.

• We saw a notable reversal in interest rates last week likely due to the geopolitical catalyst but also nudged by a series of dovish Fed comments noting high UST rates as lessening the need for additional tightening, suggestions that the implied market terminal rate is too high and downplaying the September CPI report.

• High and rising UST rates mean higher debt service for businesses, government, and consumers as well as higher costs for projects and investments and mark to market losses on bond portfolios.

• Torsten Slok from Apollo made note that with a 5.25-5.50% Fed funds rate and an estimated 2.5% neutral rate, corporate debt service coverage ratios are beginning to grind lower. Bianco Research echoed the same sentiment from the perspective of consumer interest expense.

• Thirteen Fed speaking engagements and the release of October’s FOMC minutes reinforced a ‘no change’ rate decision at the upcoming November 1st FOMC meeting, currently priced at an 87% probability in the futures market. Future meetings carry only 32%-42% probabilities of a hike.

• Third quarter earnings season kicked off with major banks reporting last week. Bottom line consensus is calling for -0.3% earnings growth, which if exceeded would mark the first positive YOY earnings results since 3Q22. Projected revenue growth is 1.7% and margins are expected to improve.

• It was interesting to see UST yields decline sharply on the back of a blowout jobs report, relatively benign inflation report, and continually improving economic outlook.

• September headline and core CPI registered 3.7%/4.1% YOY and 0.4%/0.3% MOM.

• The September NFIB Small Business Optimism Index declined slightly from 91.3 to 90.8, just short of the consensus forecast of 91.2.
• Consumer Sentiment for October registered a five-month low of 63.0, below consensus estimate of 67.5 and the prior month’s reading of 68.1.

Market focus points last week included some stimulative policy moves in China, risk of waning disinflation momentum, U.S. auto industry strikes, and some final key economic data points heading into this week’s closely watched FOMC meeting. Equity and bond markets responded in line with a higher for longer fashion, as U.S. equity markets closed down slightly while interest rates closed the week right in line with late August highs at levels not seen since 2007.

• Inflation data last week including CPI, PPI, and fundamental economic activity added anxiety to markets along the lines of the second wave inflation narrative which argues we should not be expecting a clean straight line to 2% inflation and the post pandemic world may just be different.

• Last week’s economic data isn’t expected to influence the FOMC market base case of no change in Fed Funds rate this week but a possibility of one more move higher before year end.

• The NY Fed Survey of Market Participants showed only a 5% chance of peak Fed funds surpassing 6%, relatively in line with futures market pricing.

• The ECB delivered a dovish 25bps hike last week where internal projections see inflation of 5.6% in 2023 falling to 3.2% and 2.1% in ‘24 and ‘25 respectively – a public forecast followed by Lagarde presser stating these high levels maintained long enough, should drive inflation down.

• Eaton Vance published LCD data illustrating S&P’s default forecasts for the coming six months with the current rate of 1.7% either rising to 4.5% (pessimistic), falling to 1% (optimistic), or leveling off to 2.5% (base case). Distressed loan data is also signaling some turbulence ahead.

• A research note from Goldman last week on the U.S. equity market concentration issue painted a stark contrast between U.S. and non-U.S. markets while an unrelated note from J.P. Morgan illustrated the cost of higher rates hitting smaller companies disproportionately harder as well.

• The UAW implemented targeted strikes at the big three automakers last week in a widely expected move given how far apart both sides are at the negotiating table.

• The PBoC cut banking system required reserves and injected $25b into the system last week, raising hopes for recovery in China and renewed focus on stimulus measures.

• August headline and core CPI registered 3.7%/4.3% YOY and 0.6%/0.3% MOM.
• August headline and core PPI registered 1.63%/2.16% YOY and 0.74%/0.19% MOM.
• Retail Sales for August of 0.56% (+2.5% YoY) came in higher than the 0.1% expected and above the prior two months’ pace, but gasoline sales seem to have played a large part in the report.
• Industrial Production in August topped forecasts, growing 0.38%, down slightly from the prior month but above the long-term average of 0.26%.
• U of M Consumer Sentiment fell from 69.5 to 67.7 (-2.6%) in September. It is up 15.53% from this time in 2022 but remains well below its historical average of 86.
• The NFIB Small Business Optimism Index for August declined 0.6 to 91.3, slightly below consensus call of 91.5.

• Markets anticipating this week’s FOMC meeting and fresh inflation data have settled into a “good news is bad news” narrative highlighting risk asset opposition to a higher rates for longer path of monetary policy over the coming 12-18 months.

• Adding to the complicated landscape for monetary policy is WTI oil prices surging to their highest levels since November and Brent surpassing $90 for the first time this year. Drivers include OPEC 2.0 extending production cuts and resilient demand from the U.S., EU, and China.

• BofA FMS highlights how unlevered asset managers are holding near record net long positions in 10yr Treasury futures (a bet on falling bond yields) while leveraged fund COT data shows a near record net short position in 10yr Treasury futures (a bet on rising bond yields).

• USD strength has been notable with the Euro falling versus the USD for an eighth consecutive week, USD/CNY hitting its highest level since December 2007, and the overall trade weighted USD bouncing higher after a fall from record highs.

• A research note from Bianco Research reminds us of the high correlation between bank lending standards and bankruptcy filings, while credit spreads continue to see blue skies ahead, injecting a bit of caution into the summer risk asset rally.

• Tightening lending standards leading to a credit cycle across commercial credit and real estate is becoming clear with regional, international, and local banks alongside the CMBS market holding the lion’s share of real estate loans and buy side investors of all colors holding commercial loans.

• Apollo made note last week of the estimated $7.6trn in US government debt maturing over the next year which logically should translate to persistent upward pressure on interest rates.

• The impact of high mortgage rates on mortgage applications and existing home sales is clear while renting as an alternative is being accommodated by record high multi-family construction.

• The ISM Services Index exceeded forecasts and the high end of the range, coming in at 54.5 versus a 52.4 consensus in August. The final PMI Services Index was revised down to 50.5.

• Initial Unemployment Claims of 216k took the 4-week average down from 237.5k to 229.25k.
• China’s August Caixin services PMI fell to 51.8 from 54.1 and German industrial orders fell 11% in July.
• Durable Goods New Orders declined 5.23% in July after a strong 4.29% reading in June.
• July Factory Orders declined by 2.1%, slightly less than the -2.6% expected.

Equity markets put a challenging August in the rearview mirror last week with a bounce higher from short- term oversold levels. Highlights of the week included a very busy economic calendar which seemed to have left markets with somewhat of a Goldilocks feeling heading into the long Labor Day weekend. U.S. markets closed up 2.5%-3.5% while non-U.S. markets were up 0.75%-0.90%. We saw a recovery rally across technology, consumer, and communications while defensives lagged. WTI crude oil rallied to a new 2023 high, now back up over $85, and took the wider commodity complex along for the ride while bond yields retreated further, particularly in the 2-5yr belly of the curve.

• Bespoke reminded us that while September has historically been the worst month of the year (DJIA), October-December have historically been the best. That said, comments like that call for a reminder of the cost of timing the market which, absent a crystal ball, really doesn’t work well.

• The first eight months of the year have been highlighted by dominant growth stocks and lagging small cap stocks. Additionally, they have produced a welcomed mirror image of 2022 when both stocks and bonds fell sharply. 2023 has seen robust gains in stocks and marginal gains in bonds.

• U.S. equity market valuations remain alarmingly high (technology orientation), but non-U.S. market valuations are solidly attractive while market breadth is at its narrowest since 2003.

• Last week’s inflation and job market data sent a dovish ‘JOLT’ into markets last week with softer economic data translating to increased expectations for Fed cuts in 2024.

• A new Financial Conditions Index (FCI) created and monitored closely by the Fed suggests conditions have relaxed back toward a neutral effect on growth thanks largely to the robust equity market rally and resilient housing market valuations.

• An illustration from MSCI lays out the increasing stress happening in commercial real estate with distress and foreclosure counts both clearly on the rise.

• China announced a tax cut on trading and that it plans to take more stimulative steps, but the 2023 equity market is not projecting a favorable runway looking forward with the belief that more concrete steps are needed.

• July Employment Report registered 187,000, above consensus estimate of 170,000 and near the high end of the forecast range of 40,000-190,000. The unemployment rate increased from 3.5% to 3.8% and labor market participation increased 0.2% to 62.8%.
• Average Hourly Earnings grew 0.24% MOM and 4.29% YOY while Personal Income grew 0.20%, all in line with consensus and slightly lower versus the prior month’s pace.
• July’s JOLT Survey reported a notable decline in job openings from the prior month 9.165mm reading to 8.827mm, well below consensus forecast of 9.559mm and the forecast range of 9.524mm – 9.570mm. The opening to unemployed ratio has fallen from 2.0 to 1.5 since January.
• July headline PCE inflation registered 3.28% YOY alongside core readings of 0.20% MOM and 4.24% YOY. Personal Consumption increased from 0.63% to 0.79% MOM.
• U.S. August ISM Manufacturing Index beat consensus (47.6a vs 46.8e) and the final Manufacturing PMI was revised higher from 47.0 to 47.9.
• The August J.P. Morgan Global Manufacturing PMI improved slightly from 48.6 to 49.0.
• 2Q GDP (second estimate) was revised downward from 2.4% to 2.1%, well under the forecast range of 2.4%- 2.5%.
• Consumer Confidence in August came in well short of expectations (106.1a vs 116.5e) and well below the consensus estimate range of 113.0-119.3).
• June Case Shiller Home Price Index grew 0.9% MOM but declined 1.2% for the year, both generally in line. July Pending Home Sales (0.9%a vs -0.4%e) were stronger than expected.

• The move higher in yields is again posing a risk to risk assets as rates have climbed to levels not seen since 2007. Resilient economic growth, inflation, and heavy UST supply are all contributing to the move higher in yields.

• Given robust personal consumption has meaningfully underpinned economic growth, measures of excess savings, real wage growth, sentiment measures, and labor market dynamics are key metrics. That said, differing measures of excess savings are producing a variety of perspectives.

• FOMC meeting minutes released last week suggested that September may see another policy decision to ‘skip’ but rate hikes in later months this year are in play. Markets are pricing in no move in September but two rate cuts by July of next year.

• From a monetary policy perspective, hawkish inflation risks include strong commodity markets (energy), robust wages, and above trend growth. The Dovish/soft landing case consists of continued disinflation trends and resilient consumption.

• The Atlanta Fed GDPNow model increased its 3Q forecast on the back of strong personal consumption (retail sales) to 5.8%. Talk of recession on corporate earnings calls fell dramatically but Bloomberg economist survey results continue to see troubled waters ahead.

• The U.S. housing market is getting pulled in two different directions with the highest mortgage rates in 23 years freezing buyers and sellers and pushing home ownership beyond the reach of many Americans while market technicals remain supportive of new home construction.

• Last week the PBOC cut its MTLF by 15bps to 2.5% and the reverse repo rate by 10bps to 1.8% but categorized both moves as liquidity driven, not a change in their monetary policy stance.

• Retail Sales in July rose 0.7%, more than consensus 0.4% and the forecast range of 0.2%-0.5%. Ex-Vehicles (1% vs 0.4%) and Ex-Vehicles & Gas (1% vs 0.4%) also handily beat consensus.

• August Housing Market Index registered 50, well below consensus forecast of 56 and the forecast range of 55-58.
• July Housing Starts (1.452M vs 1.455M) and Permits (1.442M vs 1.464M) both came in slightly under their respective consensus forecasts.
• Industrial Production in July grew 1%, more than the spot consensus of 0.3% and the forecast range of -0.2% to 0.7%. Manufacturing Output (0.5% vs 0% and Capacity Utilization 79.3% vs 79.1%) also exceeded estimates.

Market intake points last week were limited to a few key inflation readings and the back end of 2Q earnings reports. In typical mid-August fashion (weak tape/heavier action) the S&P 500 moved a good deal on relatively thin volume finishing with a second consecutive down week following four straight weekly gains – taking what felt like an overdue breather. Last week big technology and small caps again lagged while energy, healthcare, and rate-sensitive REITs and utilities led the way. For the week, the S&P 500 closed down 0.31% (S&P 500 equal-weight slightly outperformed again) while international developed (-0.04%) and emerging (- 2.42%) were mixed with Japan/Europe generally flat but China fell 3.2%. Bonds were weaker across the board with losses concentrated in the belly as opposed to the wings. The 10yr UST yield continued to rise, closing at 4.16%. Commodities were pretty flat with no notable moves while the USD posted a respectable 0.81% gain in sympathy with the move down in risk assets.

• We saw mixed but generally continued moderation in monthly inflation data last week with CPI, PPI, and U of M sentiment readings. Fed funds futures have reflected the trend, now pricing in no remaining hikes for 2023 and cuts beginning in 2024.

• The impact of shelter on inflation data remains prominent. A new model from the San Francisco Fed to forecast OER/real estate prices, concluded U.S. shelter inflation may turn negative in 2024, exacting a meaningful deflationary force on CPI.

• The 2yr/10yr slope has steepened (less inverted) notably over the past few weeks, declining from 0.99% on July 19th to as low as 0.67% last week – a bond market that may be signaling rate cuts on the short end but a higher inflation shelf impacting the long end.

• The consumer is experiencing rising real wages for the first time in over two years, but conflicting data metrics (credit card and auto loan delinquencies) are simultaneously raising some concerns.

• The U.S. Treasury market may be in the process of showing us that beyond inflation, default, and interest rate fluctuations influencing bond prices, excess supply may well be climbing the board.

• An early read on the Atlanta Fed GDPNow model shows an acceleration in third quarter GDP to 4.1% from the Q2 reading of 2.4% with positive contributions across the C + I + G + NX board.

• Second quarter earnings season is close to completion with the headline S&P 500 contracting approximately 5%, driven mostly by a 51% decline coming from the energy sector. Profit margins continued to normalize from the record Q1 2022 high back to normal longer-term levels.

• Export data out of China provided a clear contractionary signal with exports falling 14.5% in USD terms, further than the expected 13.2% decline. Imports also contracted more than expected (-12.4% vs -5.6%).

• July CPI was generally in line with expectations on both headline (YoY 3.2%a vs 3.3%e) (MoM 0.2%a vs 0.2%e) and core (YoY 4.7%a vs 4.8%e) (MoM 0.2%a vs 0.2%e) readings.

• July PPI accelerated to +0.31% from a friendly prior month reading of -0.08%, surprising to the upside versus consensus forecasts on both headline and core readings.

• July NFIB Small Business Optimism Index registered 91.9, in line with consensus expectation for 91.5 and a slight improvement over the prior month reading of 91.0.

• August’s U of M Consumer Sentiment stayed generally in line with July’s reading, registering 71.2 but also delivered some disinflationary sentiment readings.

Markets kicked off the new month by taking in a large number of Q2 earnings reports and a healthy calendar of economic reports in a challenging week for risk assets. The S&P 500 broke a three-week win streak by posting its worst week since the March banking sector turmoil, falling 2.27% while most other major indices joined the S&P in the red including the Nasdaq (-2.85%), Russell 2000 (-1.22%), international developed (- 3.06%), and emerging (-3.3%) markets. Bond yields declined through 5yr maturities but increased beyond that adding to a string of volatile weeks in the bond markets. WTI oil increased 2.7% but most other commodities declined on the week while the USD enjoyed a risk off bid, increasing 0.39% on the week.

• Equity markets have experienced some consolidation to begin August on the back of two strong months due to a combination of rising yields, policy uncertainty, and an overbought/overvalued market conditions reminding us the S&P 500’s reliance on mega caps cannot extend indefinitely.

• Bond yields fell on shorter maturities and rose across longer maturities, ending with yields of over 4% across the entire yield curve. Large Q3 Treasury issuance, labor market dynamics, and perhaps a marginal nod to the Fitch downgrade contributed to these moves.

• Whether or not we’re out of the woods of inflation could be a significant determinant for financial markets over the next 12-24 months with unexpectedly renewed inflation pressures a primary risk to risk asset returns.

• The bullish narrative of peak Fed funds rate/soft landing from here stands opposed to the bearish narrative of higher for longer and lagged effects of the very aggressive tightening cycle yet to work its way fully into the economy.

• BCA Research notes while valuations have little predictive value over the short term, they are a significant determinant to longer term (strategic) investing outcomes as evidenced by a simple regression on P/E multiples and subsequent returns on the S&P 500.

• Bianco Research noted the SLOOS cyclical and balance sheet pressure on small and mid-sized banks is translating as expected to tightening lending standards, posing a headwind to economic growth looking forward.

• Fitch Ratings’ downgrade of U.S. debt from AAA to AA+ grabbed headlines (and podiums) but did not translate to any meaningful market impact. Analysis by JPM and the ratings agencies suggests a one notch downgrade by all three agencies narrows yields by approximately 8bps.

• Chile became the first major emerging market central bank to cut rates (-100bps) and signaled more rate cuts are likely to follow.

• July payrolls increased by a less than expected 187,000 (200,000 expected) and the unemployment rate fell from 3.6% to 3.5%. Average Hourly Earnings growth remained at 4.4% (0.4% MoM), against consensus calling for a decline.

• June’s JOLT Survey revealed 9.582M job openings, slightly under consensus forecast of 9.650M but within the forecast range.

• July’s ISM Manufacturing Index registered 46.4, in line with the spot consensus forecast of 46.5.

• Eurozone 2Q GDP registered 0.3% q/q, returning to positive growth following a 0% Q1 and -0.1% Q2. Headline inflation eased from 5.5% to 5.3%.

• Stretched valuations, overbought technicals, decent earnings, resilient growth, strong labor markets, and a resulting mixed outlook for inflation/monetary policy suggests a differing short-term versus cyclical outlook for risk assets.

• The FOMC meeting delivered the expected 25bps hike to Fed Funds, increasing it to 5.25%. They stopped short of overtly signaling a pause, opting for a ‘meeting by meeting’ approach. Nothing changed in the post- meeting statement while Powell’s post-meeting presser acknowledged favorable inflation trends and resilient (too?) labor markets.

• The ECB meeting last week delivered the expected 25bps hike taking the deposit rate to 3.75%, equivalent to the October 2000 record high, the refi rate to 4.25%, and marginal lending facility rate to 4.5%. The BOJ kept rates unchanged but surprised markets by changing its YCC program.

• Refinitiv IBES data at the midway point of Q2 earnings season has earnings declining 6.4% alongside upside earnings surprises at 78.7% and revenue surprises at 64%.

• Public equity valuations aren’t alone in the lofty zone. Private equity (buyout) valuations look very stretched relative to historical ranges with year-end 2022 sporting purchase price multiples of 13x and debt multiples over 7x.

• China’s Politburo signaled only targeted stimulus measures as opposed to broad based fiscal or monetary loosening. The Hang Seng fell 2% on the announcement.

• Russia’s refusal to renew the Black Sea Grain Initiative after expiration on July 17th raises supply side risks in ag markets. Wheat and corn prices have surged by 16% and 11%, respectively since Russia’s action.

• Second quarter U.S. GDP came in well above the spot consensus forecast (2.4% vs 1.5%) and more in line with the Atlanta Fed GDPNow modeled forecast. Personal Consumption Expenditures of 1.6% came in slightly ahead of consensus but within the 1.1%-4.1% range.

• June PCE inflation data showed continued deceleration with headline readings of 3.0% YOY / 0.2% MoM alongside core readings of 4.1% YOY / 0.2% MoM.

• Second quarter Employment Cost Index grew 1% versus spot consensus of 1.1% and a forecast range of 1.0%-1.3%, a reduction from Q1 reading of 1.2%.

• Personal Consumption Expenditures of 0.5% ticked higher and slightly exceeded estimates while Personal Income of 0.3% fell slightly under the spot forecast.

• July U.S. flash PMI (C,M,S) registered 52.0, 49.0, 52.4 with manufacturing exceeding the forecast of 46.0 and services falling short of consensus forecast of 54.0.

• July’s flash non-U.S. PMIs (C,M,S) for the Eurozone (48.9,42.7,51.1) and UK (50.7,45.0,51.5) revealed some downside surprises.

• Consumer Confidence reading for July registered 117.0, well above consensus estimate of 111.8 and the forecast range of 108.0-116.0. July’s final revision to UofM Consumer Sentiment took it down from 72.6 to 71.6.

• The June Durable Goods Orders reports on New Orders (4.7% vs 0.5%), Ex-Transportation (0.6% vs -0.1%), and Core Capital Goods (0.2% vs -0.1%) beat consensus forecasts across the board.

• Case-Shiller Home Price Index for May posted a gain MoM of 1% versus consensus estimate of 0.8% and a YOY decline of 1.7% versus a consensus call for a 2.5% decline.

• New (697k) and Pending (0.3%) Home Sales were both within their respective forecast ranges.

Market drivers last week included second quarter earnings reports and a continuation of U.S. disinflation and economic soft landing themes. The S&P 500 and NASDAQ both marked 15-month highs, closing up marginally for the week. Bonds traded down slightly with interest rates rising in the belly of the curve (2y, 3y, 5y) while the 10yr yield remained largely unchanged at 3.84%. The USD (+1.16%) and commodities (+2.17%) both edged higher on the week with the energy complex leading the way.

• A look at equity market technicals shows we may be somewhat extended (overbought) in the short term, the longer-term trend remains constructive.

• Liz Ann Sonders posted a useful illustration highlighting the notable improvement in breadth (participation/leadership) we’ve seen since early June and Bianco Research followed that note with a similar observation through a market cap lens.

• Q2 earnings season, with 18% reporting, has a blended earnings decline of 9.0% and revenue of -0.3%. The street is still projecting recovering earnings growth in the second half with 3Q estimates of +0.1% and 4Q of +7.5%.

• We’ve seen some material USD weakness following the U.S. CPI report triggering debate as to what exactly this weakening USD may be signaling.

• Expectations of a U.S. recession have receded slightly with the soft core CPI report feeding a soft landing narrative backed by sustained consumption, a resilient labor market, and robust service sector activity. The counter argument, however, is supported by recessionary manufacturing conditions, restrictive monetary policy, weak LEIs, and a deeply inverted yield curve.

• An FT article highlighted positive trends in private debt with demand supported by the high costs of public issuance, fewer reporting obligations, loss of business/operational control, and less rigor surrounding related party transactions.

• Bloomberg noted home equity dry powder has increased 56% over the past three years; Black Knight estimates the magnitude at $28.7t ($9.3t accessible at 20%).

• A lackluster reopening trend and weak GDP report has China signaling potential stimulative measures including a currency peg adjustment, relaxed mortgage requirements, and potential rate cuts.

• A Bloomberg article last week highlighted a significant increase in bankruptcies reaching the highest levels since 2010 but the article sparked some intense debate on the BCA Research weekly research call.

• June headline Retail Sales came in below expectations (0.2% vs 0.5%) but ex-vehicles (0.2% vs 0.3%) and ex- vehicles & gas (0.3% vs 0.3%) readings were both more in line with consensus.

• The four week moving average of Initial Jobless Claims fell from a near-term high on June 24th of 256,750 to last week’s level of 237,500.
• Industrial Production in June was soft, well under forecasts (-0.5% vs 0.0%) as were the Manufacturing Output (-0.3% vs 0.0%) and Capacity Utilization (78.9% vs 79.5%) readings.
• July’s Housing Market Index came in right at the consensus forecast of 56 after rising 5 points to 55 in June.
• June Housing Starts (1.434M vs 1.48M) and Permits (1.440M vs 1.483M) both came in below forecasted
• levels but within the larger consensus range.
• June Existing Home Sales cooled slightly from May’s reading to 4.16M.