Last week, the markets were torn between the FED’s message on Wednesday, continued inflationary pressures and weak economic growth data, yet for all the uncertainty, Wall Street posted a positive week overall. For the week, the Dow Jones Industrial Average rose +3.0%, the S&P 500 Index increased by +4.3%, and the tech-heavy NASDAQ moved higher by +4.7%. Continuing its month-long rally, the 10-Year U.S. Treasury Bond fell another 10 basis points during the week, to close at 2.67%; quite an unusual feat considering that the FED is technically in a tightening (moving interest rates higher) cycle. The yield curve continued its inverted stance and GDP figures released last week confirmed that we saw two back-to-back quarters (albeit very modest dips) of negative GDP (economic growth).   

Markets (as of 7/29; change YTD) 

Global Economy 
At last week’s FOMC meeting, the Federal Reserve raised rates by 75 basis points (0.75%), bringing the benchmark fed funds rate to 2.50%, the highest level since 2019. Fed Chair Jerome Powell noted in his commentary that the fed funds rate is now close to the Fed’s estimate of a neutral rate, indicating an official end of the post-pandemic easy money policy. Chairman Powell also noted that by the end of the year, fed funds could be at their terminal rate of 3.00% to 3.50%. There may only be one or two more rate hikes this year thereby slowing or ending this tightening cycle. Chart 1 below from FactSet shows the current market expectations by Fed meeting date. Importantly, as early as March 2023, we could see rate cuts as the Fed begins to deal with slowing economy.

As noted above, the markets ended the week, and the month, with strong gains. Clearly, the markets are banking on a Fed pivot (moving from tightening or raising rates, to easing or lowering rates). GDP figures released last week for the second quarter 2022 showed -0.90%, and when combined with the first quarter of 2022 at -1.60%; showed we have a “technical” recession in place – which economists historically cited two back-to-back quarters of negative GDP signaled a recession. The GDP data is accurate and when combined with many recent missed EPS releases by companies such as Intel and Proctor & Gamble certainly point to a slowing economy, which goes into the Fed’s decision to consider a pivot sometime in late 2022-23. A pivot means lower interest rates in the future and that is what the markets are rallying on. Chart 2 (from FactSet) shows the broad performance of several major indexes thus far in the 3^rd Quarter 2022. Every sector is higher, led by the NASDAQ. 

Policy and Politics 
The markets are banking on the Fed doing its job in combating inflation, however we have yet to see any indication that inflation is moderating except in lower commodity prices as we discussed last week. For the markets to continue their recovery, we must see some real impact on the inflationary pressures impacting consumers. Note that gasoline prices are well off their highs of $4.50-5.00/gallon, and this is a commodity that immediately impacts all consumers. Further downward pressure on gasoline could be seen in the months ahead as global economies cool and demand for oil lessens.   

What to Watch 

• August 4^th U.S. Initial Jobless Claims estimate +249,000 vs prior month +256,000 
• August 5^th U.S. Non-farm payrolls estimate +250,000 vs prior month of +372,000 
• August 5^th U.S. Unemployment rate estimate 3.6% vs prior rate of 3.6% 

Although the market was dealt some mixed signals on the economy and earnings, overall, we ended resoundingly positive by week’s end and all three major indexes posted strong gains. Preliminary July manufacturing and services sector reports all signaled slowing business activity, notably for the U.S. services sector, conversely, Q2 earnings season kicked into a higher gear and of the 104 S&P 500 companies that have reported, 56% have topped revenue forecasts and approximately 72% have bested profit projections, per data compiled by Bloomberg. Many investors feel the best indicator of future economic growth is the stock market and that gauge helps in projecting a coming recession. Several prognosticators are predicting a recession within the next few quarters. It seems likely that we will have a technical recession (two quarters of negative Gross Domestic Product), but we believe a cyclical recession (one where there is severe employment destruction) is unlikely. We take a deep dive into several recession-related economic indicators below. For the week, the Dow Jones Industrial Average rose +2.0%, the S&P 500 Index +2.6%, and the NASDAQ moved higher by +3.3%. The 10-year U.S. Treasury Bond fell 16 basis points last week to close the week at 2.77%, once again giving investors over 1.00% for the week, and solidly inverting the yield curve. 

Markets (as of 7/22/2022; change YTD) 

Domestic Economy 

Chart 1 below (from the Federal Reserve Bank of St. Louis) shows the 10-2 Treasury yield spread, which is the difference between the 10-Year U.S. Treasury Yield and the 2-Year U.S. Treasury yield. A spread that approaches zero, or in the current market, is negative, (meaning an investor is getting less return for extending their bond’s maturity) has historically been a precursor to a recessionary period. However, the time between an inverted yield curve and a recession ranged from 6 to 24 months afterwards; meaning, this is a far-leading indicator. As noted above, the 10-Year U.S. Treasury fell again last week, hitting 2.77% down significantly from the 3.48% yield it hit in June of this year. It is likely that institutional investors who are still sitting on piles of uninvested cash saw the 10-Year U.S. Treasury yield above 3.00% compared with recent anemic levels well below 1.00% as an attractive investment and that move back into Treasuries has pushed yields lower. 

Chart 2 below (from Valley National Financial Advisors and YCharts, recessions shaded) shows the Composite of Leading Indicators by the OECD. The index is published monthly by The Conference Board. It is used to help predict the direction of global economic movements in future months. The index is composed of 10 economic components, such as: employment activity, manufacturing orders, and stock market behavior. Businesses and investors can use the index to help plan their activities around the expected performance of the economy and protect themselves from economic downturns. This indicator turned negative in September of 2021, predicting a recession was looming as every previous recession saw a sharp drop in the Composite of Leading Indicators.  

Chart 3 below (from Valley National Financial Advisors and YCharts, recessions shaded) shows U.S. Unemployment rate and U.S. Existing Home Sales charted since 2000. We see how in previous recessions unemployment rose dramatically and home sales slowed. Currently, we have the opposite where unemployment is at an historic low of 3.6% and home sales, while slowing a bit due to recently higher mortgage rates, are still strong. With these two indicators continuing to refute a looming recession we believe a cyclical recession is unlikely in the near term. 

Last week we showed how several measures of inflation were starting to come down. Key commodities like copper, lumber, and oil are down from recent highs and manufacturing activity is slowing. Also, gasoline prices, a critical component in everyday spending, is down from recent highs. This data suggests the FED’s path to higher rates is slowing record high inflation and is impacting the super-hot economy. We show above that housing and employment remain strong rebutting calls for a looming recession. We never fail to remind readers how important the consumer is to the U.S. economy – fully 65-75% of economic activity is related to consumer spending and the consumer remains in particularly good financial health; especially when gauged by debt levels, savings accounts and still relatively low (by historic standards) mortgages rates. Pay close attention to the stock market – the true leading indicator of economic activity. The S&P 500 Index is up 5.23% since mid-June 2022, when we continued to see a softening in inflationary data. 

Policy and Politics 

• The FOMC meets this week and is expected to raise rates 75 – 100 basis points. 
• Chairman Powell’s press conference will help us understand future moves 

What to Watch 

• U.S. New Single-Family House Sold will be released at 10:00AM ET on July 26th. 
• Target Federal Funds Rate Upper Limit will be announced at 2:15PM ET on July 27th. 
• U.S. Real 2^nd Quarter GDP Quarter over Quarter will be released at 8:30am on July 28^th. 
• U.S. PCE Price Index YoY (the FED’s preferred inflation gauge) released at 8:30am on July 29^th.