The twist is that rather than incongruous events, it’s contradictory evidence and conflicting interpretations of data, asset pricing, and Fed policy that’s happening right now. As a result of these “marketheimer” events, markets are being pulled in opposing directions, netting out to no clear direction overall. Many of these issues boil down to simple questions with no easy answers. Here are a few of the most prominent ones…
- Are consumers still in good shape or will they soon crack under the weight of higher rates? Two weeks ago, the answer would have been clearly in favor of good shape based on retail sales accelerating in July and solid 2Q results and guidance from the biggest retailers. But last week, the tone from other retailers was more cautious, with rising credit card delinquency rates being one example. The collective data has provided fodder for both bulls and bears to make their case.
- Is the neutral fed funds rate (r*) 2.5% or a lot higher? Speculation was rampant leading up to Federal Reserve Chair Jay Powell’s Jackson Hole speech over whether he would indicate that the Fed’s thinking on r* has changed. Powell, probably wisely, skirted the issue by saying, “we cannot identify with certainty the neutral rate of interest, and thus there is always uncertainty about the precise level of monetary policy restraint.” While the intellectually honest answer, it won’t stop the debate between investors who argue that the short-term neutral rate is higher than 2.5%, implying that policy is not very restrictive, and others who think that the “long and variable” lags of monetary policy will soon bite hard, as they already have for some consumers and businesses.
- Are higher 10- and 30-year yields bad for growth or do they reflect a better growth outlook? There are, for simplicity, two schools of thought on this question, and they differ on how much weight to put on technical versus fundamental factors driving yields higher. The technical argument is that the prospect of large government deficits for the foreseeable future, without the benefit of extraordinarily accommodative monetary policy, is the main reason why rates have gone higher, which will ultimately be a drag on growth and financial markets. The fundamental case for higher yields is that they’re consistent with a soft landing for the US economy, which is now consensus, and nominal GDP growth staying at an elevated level.
- Are investors more inclined to “sell the rallies” or “buy the dips”? The inability of Nvidia’s share price to hold its gains after its blowout earnings is exhibit A for those suggesting that investors are looking to sell into strength rather than to add exposure. That could be the case, but any recent price action that implies a sell-the-rally mindset must be put into context of this happening after the S&P 500 was up 20% year-to-date, and 10% in June and July. From a starting point of being underweight risk assets, investor positioning data suggests that they’ve only gotten back to around neutral. And the S&P 500 is only 4% down from its recent peak, hardly a large dip to buy after a strong rally.
The bottom line: Our take is that the US consumer, and therefore the economy, should remain fairly resilient well into 2024. But monetary policy is restrictive, debates about its magnitude aside, and this will weigh on the consumer spending and growth in the coming quarters. That should result in long end yields trending lower by year-end, even if the fundamental case for a higher neutral rate and yields in the long term has merit. While investors are right to be asking these tough questions, debates about economic activity and market pricing in August should always be taken with a grain of salt. The economic outlook has not fundamentally changed in the past four weeks. But the August data that starts arriving on Friday and the Fed’s response at the FOMC on 20 September could reinforce investor concerns that have surfaced this month, or put them at ease. Hyper-tactically, the bias may be for investors to sell rallies until their soft landing expectations are reinforced. But with over USD 5.5tr in money market funds, investors have ample cash to buy dips if that happens, as we expect. Investors being sellers of rallies and buyers of dips seems apropos in the summer of Barbenheimer.
Main contributor: Jason Draho, Head of Asset Allocation, CIO Americas
Original blog: Marketheimer , 28 August, 2023.