Brian Pietrangelo:
Welcome to the Key Wealth Matters weekly podcast where we casually ramble on about important topics including the markets, the economy, human ingenuity, and almost anything under the sun, giving you the keys to open doors in the world of investing. Today is Friday, August 2nd, 2024. I'm Brian Pietrangelo and welcome to the podcast. We have a lot going on this week in the markets and in the economy, so we'll jump right into our conversation.
I would like to introduce our panel of investing experts here to provide their insights on this week's market activity and more. George Mateo, Chief Investment Officer, Steve Hoedt, Head of Equities, Rajeev Sharma, Head of Fixed Income, and Cindy Honcharenko, Director of Fixed Income Portfolio Management.
As a reminder, a lot of great content is available on key.com/wealthinsights, including updates from our Wealth Institute on many different subjects and especially our Key Questions article series addressing a relevant topic for investors each week. In addition, if you have any questions or need more information, please reach out to your financial advisor.
Taking a look at this week's market and economic news, we've got five updates we've got to share with you, so we'll try to be quick on all of them because each one of them has their own benefit of importance.
So first got the JOLTS report, the Jobs Opening and Labor Turnover Survey report earlier in the week where the number of job openings was unchanged from roughly 8.2 million for June while within separations the quits rate for those that want to leave their job also changed a little at 3.3 million.
In addition, the S&P CoreLogic Case-Shiller US National Home Price Index reported a 5.9% annual gain from May, down from 6.4% in April. Again, this is the imbalance between existing homes on the market being low supply, demand continuing to be high, therefore prices going up. So we're seeing some moderation in those price increases based on what's happening in the overall environment.
Third, we've got the Employment Cost Index that came out, which showed that wages and salaries increased 4.2% in June over a 12-month period versus 4.4% in March, again, bringing the overall labor market into balance relative to price increases and those price increases being salaries and wages.
Fourth, we had the Federal Reserve's FOMC or Federal Open Market Committee meeting on Wednesday and press conference where they left rates unchanged, but had a robust dialogue about the future state of where rates might go in terms of rate cuts later in the year, possibly September and December. So we'll get our panel's take on that. Pretty important for the week as one of the market movers.
And fifth, just this morning at 8:30, the Employment Situation Report came out from the Bureau of Labor Statistics, which has a number of key elements in it, the first being that the unemployment rate ticked up to 4.3% for July, and the new non-farm payrolls showed up at 114,000 new non-farm jobs added to the economy also for July. In addition, the new non-farm payroll revisions for the months of June and May collectively were revised downward for 29,000 new non-farm payrolls. So not a good report in terms of revisions and a loan number for the jobs market.
So we'll get into that with our panel. With that, we'll go right to Cindy to talk about the Federal Reserve's Open Market Committee on Wednesday in press conference with Jay Powell with our most important questions in terms of Cindy, what did the Fed say, what did the Fed do, and what are the implications for the overall future of the Federal Open Market Committee potential to cut rates later on in the year? Cindy?
Cindy Honcharenko:
So the Fed left all target and administered rates unchanged as expected. The federal funds rate target range remains at 5.25 and 5.50%. This marks the eight consecutive pause in this tightening cycle, and this was unanimous. The pace of balance sheet runoff was unchanged to 25 billion per month for treasuries, 35 billion per month for mortgages. The policy statement underwent modest editing that signals a small but growing concern about the labor market and continued lack of confidence on the likelihood of achieving the inflation side of the dual mandate. This is marginally more dovish than the last statement, but certainly does not lock the committee into a September rate cut.
The most dovish element of the statement is the adjustment to the balance of risks. More specifically, "the economic outlook is uncertain and the committee is attentive to the risks to both sides of its dual mandate."
In June, this sentence indicated that the risks to the dual mandate were coming into better balance. If the committee was preparing for a September rate cut, then they would have to add language to the statement indicating something to the effect of it will soon be time to adjust policy to a less restrictive stance. They clearly did not do that, but the subtle changes they made do not preclude them from cutting in September if the data warrants such a move.
Powell's press conference started off once again with a commitment to resume progress towards the inflation target. The press challenged the notion that policy rates are truly restrictive and questioned the judgment that inflation is moving towards the target, but Powell stood his ground. He was also more forthright than usual in the press conference, expressing more optimism about the recent inflation data and going so far as to say that September rate cut could be on the table.
However, the chair was careful to note that the outlook remains data dependent and that there's more work to do. But this was the clearest sign yet that the committee is close to the point of confidence that they have finally slained the inflation dragon.
So I think the bottom line is the committee's data dependent but not data point dependent. It is unlikely that the decision to cut rates will come down to a few basis points on core inflation or specific threshold on non-farm payrolls. They do have two more CPI reports and one more PCE report before September's meeting. I think it would likely take two straight months of broad-based core CPI inflation at three-tenths of a percent to diminish their confidence enough to delay a September cut.
Upcoming employment reports, today's included, are the key data point that could promote a faster cutting cycle, non-farm payroll gains at 100,000 or lower, or even a layoff driven increase in the unemployment rate closer to 4.5% could potentially spur the committee to make more than 50 basis points of cuts this year.
Essentially, I think the guidance boils down to we'll know it when we know it or to use a direct quote from the June press conference, "It is what it is."
George and Rajeev, what are your observations from this week's Fed meeting and the most recent economic data?
George Mateyo:
Well, Cindy, it seems like there was a time ago, not that long ago really, when the Fed was using this word transitory and they talked about inflation being transitory, and of course it wasn't and they were behind and had to really raise rates aggressively to get inflation back under control. As you mentioned, they've kind of got to the point where it's almost fully under control, but it took them a while to get there.
And now they've kind of seemingly shifted their focus, as you rightly pointed out, towards the labor market. And as you noted, they've got two responsibilities. One is to try and keep inflation somewhat manageable, and they also want to make sure that the overall employment situation stays relatively healthy. So you can kind of say that they've kind of almost done the job with respect to inflation, and now as I mentioned, they've kind of turned their focus from this transitory inflation narrative.
I wonder what they call or what they talked about anyway, of something called normalization, which is kind of a fancy word we're trying to get the labor market back in a normal state of flux, if you will. And it's a difficult balance for sure, and it's not easy to do.
And so now we've got this situation where the Fed is really focused more on employment, less so on inflation, and this morning's labor market report, jobs market report is going to get a lot of attention for sure. And in that report we saw a pretty notable step down in hiring to be sure and to be fair. Labor market is still growing. So I think there is probably a little bit of too much concern in the market today around a recession upon us right this moment. But at some point we have to take this very seriously in the sense that things are slowing pretty quickly, and as we talked about, sometimes things happen very abruptly like this.
So it is a step-down in the overall level of employment to be sure, and it cascades with other things that we saw earlier this week. This week ISM number that people talk about, I guess to me that's more of an anecdotal number, but still, nonetheless it suggests that things are slowing. And I think frankly, it's also important to know that when you start to see some of these numbers labor market show up that are weaker than expected, a lot of it right now anyway is driven by the supply side, meaning it's not so much that people are losing their jobs. Is just maybe there are fewer jobs being hired or maybe added, if you will.
So on the margin it does to me suggest that the economy's slowing down. This is the gross here that people have been talking about. Indeed, when we got together back in June and we talked about our mid-year outlook, we talked about this is going to be a difficult setup for the second half.
We also came into this period of time where complacency was a little bit high. We'll talk about that with Steve in a second, but Rajeev, from my perspective, I think the Fed is going to have to start thinking seriously about cutting. I'm not really thinking that this whole narrative around cutting aggressively before the next meeting is warranted unless things really fall the cliff. And to me, it doesn't seem like that's happening right now, but what's your takeaway on that?
Rajeev Sharma:
I would agree with you, George. I think the knee-jerk reaction of the market and the jobs report and the latest Wednesday's FOMC meeting, I mean we've talked about the market stringing together economic data and creating an argument for the Fed to cut multiple rate cuts this year. Cindy said it also, the Fed is back to focusing on their dual mandate, not just solely focusing on inflation but also on the labor markets. And this job report kind of puts that in focus again.
Another piece of data to support that argument by the market that we should have two rate cuts in 2024, but now we've got a third rate cut by the market being fully priced in. We see that in this tremendous move that we're seeing right now in the treasury yield curve. The two-year yield, which is most sensitive to Fed policy, right when the report came out was down 29 basis points to its lowest level in a year, and the immediate reaction from the 10-year treasury note yield was an 18 basis point move to 3.80%.
So we've talked about the two-tenth curve being inverted, and we kept moving towards an uninversion, but never really quite got there. Well, now we're just about 10 basis points of inversion left. And so there's that theory in the market as well that historically speaking, when the curve uninverts you are in a recession. This time may be different obviously, but there is that fear in the market that are we going to get to the point where there will be a recession? So you're getting a growing audience that's kind of supporting that notion as well.
But again, it's not really about when the first-rate cut is. We've said this before, it's not about when the first-rate cut is. It's about why there's going to be that first-rate cut. But now there's added questions about not only why, but what is the pace of future rate cuts.
If you look at the market reaction in the past two days, there's been a section of the market calling for the first-rate cut to be 50 basis points. We don't subscribe to that. There's also been calls about intermeeting emergency rate cuts. I think we're not at that point either right now. We still have data to look at. I continue to believe that the Fed will provide the biggest signal for the first-rate cut at the August Jackson Hole Symposium, where Fed Chair Powell will address an audience and talk about what the narrative is going to be moving forward and about that September rate cut coming into fruition.
A lot of this movement right now is going to continue to cause volatility in the bond market. We're seeing these huge swings in the treasury market. I think some of this is very overpronounced. I think what we need to see here is again, continued data that supports a narrative for a Fed rate cut. I don't think we're at that point right now where there's emergency rate cuts that are necessary.
As you mentioned, George, jobs are still being added to the market, but this is one report. We do have other reports coming before not only the August symposium, but obviously there's a lot of data that come before September as well.
So the market's going to have hold onto that. I think that one bit of relief that we may see, there's two things that can happen here. One, less treasury auctions going forward right now. In the meantime, that should also provide some relief to the market. At the same time, when you see these kinds of yields, I could anticipate a lot of corporate bond issuers decide these are good opportunities. These yields are good opportunities to come to the market and raise capital. So we could see an influx of corporate bonds coming to the market.
The demand for corporate credit has been there for quite some time. Question's going to be if that demand continues or are there too many jitters in the market right now that people want to avoid adding corporate credit risk.
So if you see issuers come to the market in droves, you could start to see some kind of opportunity for issuers to come to market at lower yields, lower borrowing costs. But the question really is going to be will the demand remain there that we've seen all year? Will investors continue to bite at these type of yields if we see a tremendous move, a sustainable move lower in coupons?
George Mateyo:
Thank you, Rajeev. So let's move over to equity, Steve, and I guess as I mentioned in my comments a few minutes ago, we're kind of coming into this period of time where there seemed to be a bit of complacency, right? We've talked about this on some of these calls that as we kind of approached the second half, it's not lost on us that frankly, like I said, complacency was kind of abound.
I mean, I went back, I think about, we talked about last week the fact that the market had a 2% down day. I went back and looked that there's actually 350 trading days, so well over a year without a 2% move down. And that actually hasn't happened in over 17 years. So we were definitely going to, maybe you might say we were going to do for this pullback, but now that we're here, earnings are coming in, they seem to be pretty decent, but maybe just not quite as strong as people thought. So again, the bar was set very high as you pointed out last week.
But as you kind of put this together, we've got a slowing economy now, clearly slowing economies. We've talked about maybe earnings fell into a press, maybe some overhype around AI and some other things. What's your thought on really where the equity market's going right now?
Stephen Hoedt:
Well, George, you're right to point out the volatility situation had kind of flagged that we were in a complacent market, right? Because basically for most of the entire months of May and June, the volatility index from the Chicago Board Options Exchange, the VIX had been hanging around 12.5, and the average over the long term for this measure is 20. Okay? So we've spiked now to sitting this morning at 24.5, so a very large move. Basically, the index has doubled in the last two and a half to three weeks, and we're back to a "more normal volatility environment." It's a two-way market.
S&P 500 is down 2.25% this morning. On the heels of that jobs number that was weak relative to consensus and probably a little bit more concerning, we saw downward revisions to the June numbers. And I think the market is pricing in the ballpark of four rate cuts over those last three Fed meetings versus two rate cuts a month ago.
So clearly we've got a defensive pill to the market. Now, when you look at the way that that's played out through performance, if you take a look at pairs, which we watch, so cyclicals relative to defensives is one, that had a four sigma move yesterday relative to history. That's the biggest move to the downside since 2010. So we're starting to get to the area where there's a lot of negativity priced in, but you're in a classic defensive posture. You're seeing big outperform small right now again. You're seeing strong balance sheets outperforming weak, defensives over cyclicals, min ball over high ball, all those classic defensive things are there.
So I think that what we want to do is continue to emphasize to people to zoom out. If you've got things you like where you have confidence, you step up and you use these opportunities add to positions when stock's at levels that you think are attractive.
But what's been clear as we've gone through this earning season is that this is not the right time to have a mixed print to come in and to have a print where maybe you hit numbers, but your guidance is a little off, or you have good guidance, but your numbers are a little off. I mean, the expectations were so high for corporate earnings this quarter that it feels like these mixed prints that we're getting were exactly what we were likely going to get given the level of expectations. But they're very clearly not enough to help the market out when we've got a defensive macro that has unfolded over the last two to three weeks. And the macro is what's dominating the trade right now, not the micro.
George Mateyo:
Well, that being said, I think we'll probably just have to really stay attentive to risk just like the Fed is doing for sure. This is not lost in any of us. I think that we're in the time of year where things get a little bit squishy. I guess that's the technical term I'd use where the markets are typically thinner. Trading usually dries up over the summer.
This was a key data point this morning for sure that will be kind of processed for quite some time and parsed many different ways for the weeks to come. But I suspect, and you're right Steve, I think it is probably a time to start thinking about having your bias ready. Maybe it's too soon to buy aggressively right now. But I do think quality assets are always attractive in our view, both stocks and bonds, and I think that doesn't change in this environment. It does suggest maybe being a bit more selective, and that's certainly not lost on us either.
But I think again, if you can be patient, if you can be disciplined, find opportunities, and typically we like to lean against the grain when it makes sense to do so. So I still think that the economy's going to hang on. We've talked about this for many months now that a slowdown, not a slowing out was the most likely scenario. That still seems to be the base case, but of course, we'll continue to watch the overall evolving narrative around the job market, what the Fed might do. Of course, we have the election to contend with, which could also be a source of volatility. But absence that, I think, again, this is going to feel a bit uneasy for the next few weeks or so, but hopefully the smoke will [inaudible 00:18:30] clear as we move to the back half of this year.
Brian Pietrangelo:
Well, thank you for the conversation today, George, Steve, Rajeev, and Cindy. We appreciate your insights. And thanks to our listeners for joining us today. Be sure to subscribe to the Key Wealth Matters podcast through your favorite podcast app.
As always, past performance is no guarantee of future results, and we know your financial situation is personal to you. So reach out to your relationship manager, portfolio strategist, or financial advisor for more information, and we'll catch up with you next week to see how the world and the markets have changed and provide those keys to help you navigate your financial journey.
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