Underappreciated Good News
What happened last week?
- The S&P 500 gained 1.01%
- The Dow Jones advanced 0.66%
- The Nasdaq jumped by 2.02%
This week, attention should shift from central banks to jobs and 2Q23 earnings releases.
Economists expect the number of jobs created in July to tally 190K and be met with an unchanged 3.6% unemployment rate.
3 Things to Know
Resilience in markets
The US Federal Reserve has now delivered 525 basis points of rate hikes in less than 18 months.
It has also reduced its balance sheet lending by $670 billion, even as it funded a new lending program to support banks holding government securities devalued by the Fed’s massive rate hikes.
At a press conference last Wednesday, Fed Chairman Powell acknowledged that US monetary policy had moved into “restrictive” territory. Powell noted that it will take a long time for the Fed’s preferred measure of core inflation to fall to 2%.
To us, this means that the Fed should be done tightening long before that level is reached. If inflation was credibly falling toward the Fed’s objective, he suggested policymakers would not seek to keep monetary policy restrictive.
We believe this will require an indication from the Fed that labor markets are loosening. In short, Powell’s comments suggest the Fed won’t require a “traditional” recession to back off from restrictive monetary policy.
Making headway on inflation
The Fed’s progress on underlying inflation measures seems underrated, in our view. US services prices ex-shelter have slowed from a peak of 8% to 3%.
Why would these prices have risen so rapidly and slowed so sharply when wages have only drifted higher?
A post-Covid economy hasn’t yet reached a stable equilibrium.
When the US services sector finally began to reopen more than a year after the initial global Covid shock, demand skyrocketed at a 24% year/year pace and suppliers of services were overwhelmed.
Services spending has subsided to an 8.6% spending pace in nominal terms.
While this is still too strong, pent-up demand is being satisfied. CGWI believes restrictive monetary policy will speed the rebalancing of supply and demand in the economy already underway.
Regional equities opportunities ahead
China’s economy and markets have struggled for so long that many investors have given up. But Chinese authorities have sufficient policy tools to stabilize faltering economic growth and restore sentiment.
The breadth and consistency of recent policy announcements is notable. CGWI is more convinced that growth is likely to recover moderately in the second half.
This will likely lead to a rebound in equities and currency, particularly if the US Fed becomes less hawkish and the USD softens further.
Of course, the lack of “bazooka” policy stimulus may continue to frustrate some investors as will the rate of implementation. Japanese equities have been on fire this year, with the TOPIX (Tokyo Stock Price Index) up 21% in yen terms, outpacing even the AI-driven S&P 500.
Over the past five years, the TOPIX returned 8.3% annually in yen terms and 2.8% in USD, while the S&P 500 returned 12.3%. The currency impact may have kept many investors away, but we believe that relationship could be changing too.
See our weekly CIO Strategy Bulletin for more details