- Global risk-off sentiment continues - U.S. equity markets are modestly lower on global growth concerns. The economic calendar was light today, but investors remained cautious ahead of the U.S. inflation data and the Fed rate announcement next week. European equities were mixed, but Asian stocks pulled back following weak trade data coming out of China. China confirmed the easing of testing and quarantine rules in a major step towards reopening, but that move had been widely anticipated by the markets, with Hong Kong equities rallying 32% over the past month. Elsewhere, oil erased its 2022 gains, falling to its lowest since last December. Consistent with the risk-off tone in the markets, the 10-year Treasury yields fell to 3.41%.
- Slowdown worries weigh on markets - Recent economic data have stayed resilient, with last week's job gains highlighting the ongoing support to household incomes from the still-tight labor market. However, there are some clouds on the horizon, which leading bank executives highlighted yesterday at a financials industry conference. This is also the message from the yield curve, which is now the most inverted since the early 1980s.1 We think that the Fed's aggressive interest rate hikes and sharp rise in borrowing costs will hit the economy with a lag, and as a result the risk of a recession is high. However, a recession is not a foregone conclusion, and if it happens, we think it will be a shallow or a mild one compared with history. Household finances are in decent shape compared with prior downturns (less debt & more savings), the banks are in a strong financial position, and any weakness in employment gains should be moderate because of the high number of job openings. It is also important to remember that the stock market tends to move ahead of the economy by about six months. In our view, the potential for weak growth is well-anticipated at this point.
- Markets await CPI and Fed next week - With inflation and Fed policy being the two most important market drivers this year, it is not surprising that there is some nervousness ahead of the November CPI reading next Tuesday and the Fed's rate announcement on Wednesday. After four consecutive 0.75% rate hikes, a slowdown to 0.5% in December seems the most probable move. But even though inflation has started to ease, it remains too high for comfort, and officials will want to see several consecutive months of lower readings before considering a pause. Policymakers could signal a higher peak in rates when they release their projections, but markets are now already pricing in a terminal rate of 5% compared with the 4.6% "dot plot" projection in September. Therefore, interest rate expectations might not need to shift further. As investors and policymakers gradually gain more comfort with the idea that a trend of disinflation is developing, that sentiment can be a catalyst for lower bond yields, an easing in valuation pressures, and the start of a durable recovery.
1 Source: Bloomberg, Edward Jones
Angelo Kourkafas, CFA
- Markets finished considerably lower: Markets finished the day sharply lower, continuing Monday's sell-off, as the "good news is bad news" dynamic plays out with the ISM services index strength. Tech stocks are still under pressure, as they have been for most of the year, as higher interest rates bite and borrowing costs rise. Oil closed more than 3% lower today, trading around $74, on global demand concerns and a strong dollar. A price cap on Russian oil by most developed nations is set to be imposed, but the outcome is still uncertain, with policymakers saying it will lower the cost of energy and many economists saying it could backfire. On the international front, European and Asian shares were mixed. Treasury yields were flat on the short end of the curve and slightly firmer on the long end, putting more pressure on the inversion as fixed-income investors continue to signal economic headwinds ahead.
- Cost of oil down on global growth concerns and still-strong dollar: A strong dollar is putting pressure on demand globally for oil. When the dollar is strong, the cost of oil is higher for non-USD-denominated economies, as they must convert local currency. Geopolitical developments and global growth concerns are still weighing on the price of oil, as investors expect economic growth to deteriorate, with China sticking to zero-COVID-19 policy and inflation dampening consumer demand. A price-cap on Russian oil exports is the big overhang for the energy markets. The outcome of the price cap could determine the price of oil in 2023. Policymakers are hoping that a strong coalition of countries enforcing the cap will push the price of oil down as Russia is forced to keep selling, as oil revenues make up a large part of the country's revenues. However, Russia has already stated its intention not to sell oil to any country enforcing the cap. A sizable reduction in Russian energy exports could push up the price of oil as countries compete for oil from other suppliers. It's still too early to determine if the price-cap will work as expected, in our view.
- Good news is bad news: A better-than-expected ISM services report on Monday on the back of a strong labor report Friday sent markets lower. Investors are concerned that a strong labor market and consumer demand will keep inflation elevated and lead to higher rates from the Fed. The Fed is looking for significant progress lower in inflation before pausing or pivoting rate hikes and quantitative tightening. Investors are hoping that inflation can ease before the economy is tipped into a recession by high interest rates, or a so-called "soft landing." In our view, the probability of a soft landing is quickly shrinking as inflation remains at elevated levels. We are keeping an eye on supply-chain pressures, consumer demand, wage growth, and jobless claims for an indication that economic growth might be softening.
Sloane Marshall, CFA
- Stocks lower to start the week – After another solid gain for equities last week, markets got off to a sour start on Monday, with the S&P 500 falling 1.8% and the Dow shedding 483 points*. We'd attribute this to a carryover from last Friday's hot employment report, with markets interpreting the strong November job and wage growth as a potential threat to falling inflation. Interest rates were higher on the day, with the 10-year Treasury yield hitting 3.6%, though it should not be lost that 10-year rates have fallen as much as 75 basis points (0.75%) from their recent high. Overall, it was a rather quiet day from a headline perspective, leaving financial markets to focus on the implications for upcoming Fed rate hikes in the wake of last Friday's evidence that the labor market remains supportive of resilient consumer spending. Given this, we expect the market's focus to remain squarely on next week's consumer price index (CPI) report and the ensuing Fed meeting, during which we believe the central bank will raise its policy rate by another half a percent.
- China easing of COVID-19 restrictions – Reports out of China indicate that policymakers will dial back pandemic restrictions across a number of cities, including an elimination of the testing requirement before entering public transit or venues. Chinese markets have surged recently amid anticipation of this response, with the Hang Seng Index (Hong Kong) up 33% in the last few weeks. We suspect the broader reopening process for the world's second-largest economy will proceed with fits and starts, but we believe the prospects of better growth from China is supportive of our constructive view on emerging-market equities ahead.
- Can the rally continue through year-end? – Although 2022 has been a rough year for stock and bond returns, even with Monday's pullback, markets have rallied sharply of late, looking to close the year on a more upbeat note. From the October lows, U.S. equities are up 12%, international large-caps are up 20%, and emerging-market stocks are 16% higher*, highlighting the importance and value of staying invested during downturns in order to participate in the upswings. The coast is far from clear at this stage, but we think the year-end rally could have some gas left in the tank. As economic softness becomes more pronounced in early 2023, we expect market volatility to return, but more broadly, we think falling inflation and the resulting downshift in Fed policy tightening will ultimately usher in a more sustained expansion next year.
Craig Fehr, CFA
* Source: Bloomberg, S&P 500 index, Dow Jones Industrial Average, MSCI EAFE index and MSCI Emerging Markets index.
- Markets pared back early losses after strong employment data – While a healthy labor market is undeniably favorable for the economy, Friday's initial market reaction to a better-than-expected November employment report underscores the market's ongoing sensitivity to any trends that would require the Fed to maintain its aggressive inflation-fighting stance. Stocks pared back early losses as investors looked past Friday's jobs data and finished with major indexes mixed, giving back some of the midweek gains that came from optimism around potential smaller rate hikes ahead. Bonds moved in a similar fashion, with yields rising initially but ending the day lower. Defensives like the consumer staples and health care sectors led today, while higher interest rates are weighing on growth and technology investments, indicating a generally cautious tone to the end of the week.
- Labor market continues to show resiliency – The November payrolls report showed the U.S. economy added 263,000 jobs last month, besting consensus expectations and confirming that the labor market is not yet cracking under the weight of restrictive Fed policy. The unemployment rate remained at 3.7%, but perhaps the most notable figure from the report was the read on wage growth, which rose markedly in November. Average hourly wages were up 5.1% versus the same month a year ago, denting some of the enthusiasm around growing expectations for a smaller rate hike from the Fed later this month. Overall, we think this jobs report puts a tally in both the positive and negative categories. Ongoing strong wage growth will likely prevent inflation from falling sharply in the near term, but resilient job gains and a tight labor market will, in our view, support consumer spending and help prevent the economy from sliding into a more severe recession ahead.
- Year-end rally rolls on – Although 2022 has been a rough year for stock and bond returns, markets have rallied sharply over the last month and a half, seeking to finish off the year on a more upbeat note. Despite weakness on Friday, at one point during this week U.S. equities were up as much as 14% from their October lows, highlighting the importance and value of staying invested during downturns. The coast is far from clear at this stage, but we think the year-end rally could have some gas left in the tank. As economic softness becomes more pronounced in early 2023, we expect market volatility to return, but more broadly, we think falling inflation and the resulting downshift in Fed policy tightening will ultimately usher in a more sustained expansion next year.
Craig Fehr, CFA
- Dow moves out of a bear market: Stocks seesawed between gains and losses, finally closing with major indexes mixed, as investors look towards Friday's jobs data after initial claims data came in under expectations today. Powell removed a big overhang this week by announcing that smaller rate increases could start in December. With value outperforming growth this year, the Dow Jones has moved out of bear-market territory, well above lows reached earlier in the year. A PCE report released today showed inflation softer than expected in a sign that price growth continues to slow, but with a level still above the Fed's 2% target. European and Asian stocks were higher on the back of a U.S. rally. Treasuries rallied as fixed income investors price in a lower terminal rate. The price of oil is up in recent days after OPEC+ announced a sizable output cut to address falling demand in Asia.
- PCE Inflation index up less than expected: The core personal consumption index, a measure of inflation, was up 0.2% in October and 5% from a year ago. Although still at elevated levels, the inflation index came in lower than many had estimated. The PCE rose 0.5% in September, indicating that the trend in inflation is still lower as supply chains ease and consumer spending shifts. Including volatile food and energy, the PCE was up 0.3% month-over-month and 6% from a year ago. The Federal Reserve has been aggressive this year in raising rates to combat inflation. Inflation is well below its peak reached earlier in the year, but it's still too high for the Fed to meaningfully pivot away from restrictive territory. We expect inflation to move toward 3% next year, a level much closer to the Fed's long-term target of 2%.
- Planned layoffs are up, but the labor market shows no signs of weakness: The big question this year has been whether the labor market might start to show some signs of weakening as monetary policy tightens or remain resilient in the face of rate hikes. The job market continues to be a bright spot in the economy, with strong labor competition putting upward pressure on wages. Although companies have gone through rounds of layoffs, especially in the tech sector, initial jobless claims have remained historically low, coming in at 225,000 from the latest reading, below an expected 235,000. Wages have also seen strong growth, adding to inflationary pressures. The Fed has argued the economy can handle higher rates without being pushed into a recession, and it has pointed to the labor market as an example of economic strength. However, estimates still show economists expecting an upward move in unemployment in 2023 as tightening takes full effect and economic growth slows. Higher unemployment levels have typically been associated with lower inflationary pressures.
Sloane Marshall, CFA
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