The Week Ahead – Market Indigestion

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

For me, one of the best parts of summer is seeing my favorite fruits come back to the grocery stores. Plums, apricots, peaches, nectarines, cherries - I love them all! And, it’s not just me, my children (especially the younger one) go bonkers for summer fruits. Unfortunately, my five-year old gobbled down so many apricots last weekend that he ended up with a bad case of indigestion, discovering why you shouldn’t try to make an entire meal out of just fruit!

Shifting to the economy and markets, the bond market is experiencing a case of indigestion taking the form of an inverted yield curve. A so-called inverted curve occurs when interest rates on longer dated bond maturities are lower than their shorter dated counterparts. To wit, the yield on the Treasury bill (30-day government debt) is 2.17% while a 10-year Treasury bond is yielding just 2.01%. This means investors prefer taking more interest rate risk for less yield – seems counterintuitive. However, it is rational if it is believed rates are headed lower, which is exactly what we’ve seen since the third quarter of last year.

While the Fed has been raising the short-term Fed Funds rate, a combination of slowing global growth, benign inflation data and rising geopolitical tensions has been pushing longer-term interest rates down. Now it appears all but certain the Fed will cut the overnight rate as early as next month in order to help normalize the yield curve and help correct some of the global imbalances caused by our relatively high domestic interest rate policy. The market’s assumption that the Fed will cut rates multiple times over the next 12-18 months has been a boon to asset prices with stock indexes now trading at their all-time highs.

Many market pundits view an inverted curve as a flashing yellow light that a potential recession may be looming. As we’ve mentioned numerous times, we do not believe a recession to be imminent as there are simply too many strong economic pillars supporting the further continuation of the recovery. This week we will see the several key economic indicators, many of which continue to show resilience. Specifically, the data for housing, consumer sentiment, and jobs/wages have been very constructive. On the other hand, durable goods orders and the Purchasing Managers Index (PMI), which are being adversely affected by the global slowdown that are somewhat more concerning. As always, we will keep a close eye on these important leading economic indicators for clues as to where the economy is heading. For now, it appears to be more cherries than pits.

Data deck for June 24–June 28: