All major market indexes ended the week higher. Today’s May core personal consumption expenditures (PCE) report added to an already positive week for U.S. equities as the core PCE, a number closely watched by the Federal Reserve, increased 0.3% for the month. U.S. consumer spending declined in May as households cut back on purchases of high-ticket, long-lasting manufactured goods amid higher borrowing costs, suggesting the economy lost some speed this quarter.
There have been no shortages of obstacles along this year’s wall of worry, including rising recession alarms, elevated inflation, global monetary policy tightening, and the collapse of three major U.S. regional banks. Despite these headwinds, the S&P 500 has remained resilient and is coming into the second half with an impressive 14% gain as of June 28.
History suggests the bullish momentum could continue. Since 1950, the S&P 500 has followed up a positive first half return with an average second half gain of 6.0%. Furthermore, when first-half gains were 10% or higher, the index posted average gains of 7.7% in the second half, with 82% of occurrences producing positive results.
Fixed Income Mostly Lower
The Bloomberg Aggregate Bond Index finished lower for the second straight week following last week’s Powell’s hawkish congressional testimony. High-yield credit continues to buck the trend, following equities higher, outperforming core bonds.
With the two and ten year Treasury curve spread back to cycle lows (assuming the curve doesn’t dis-invert over the next three days), the end of June will mark the 12th consecutive month of yield curve inversion for those tenors. The longest stretch of inversion came in the late 1970s/early 80s where the curve was inverted for 21 months, dis-inverted for 4 months, before inverting once again for 13 months. Two NBER recessions took place between those periods. Outside of those periods, the longest inversion between the two and ten year Treasury that was consistently inverted was 10 months back in 2000. As long as the Fed remains determined to keep rates elevated, we’re likely going to have inverted yield curves, which will likely keep intermediate term Treasury yields in a trading range.
Commodities Mostly Higher
Energy prices ended higher this week. The major metals (gold, silver, and copper) finished the week mixed. Gold prices this week declined after reaching more than a three-month low last week, as traders are concerned about the metal’s prospects amid the Federal Reserve’s hawkish outlook.
The U.S. Energy Information Administration (EIA) stated that crude inventories dropped by 9.6 million barrels last week, far exceeding the 1.8-million barrel draw analysts forecasted in a Reuters poll. It is also larger than the 2.8 million barrel decline a year earlier. It also exceeded the average draw in the five years from 2018-2022. Given the Fed’s hawkish stance and slowdown conditions in China, some analysts believe the market could be soft, however these lower supply reports have some believing that oil prices might be bottoming.
Economic Weekly Roundup
Fed Chair Jerome Powell spoke this week in Portugal at an annual conference hosted by the European Central Bank where he reiterated his hawkish language. Powell confessed that a recession has a “significant probability” although the Fed is not forecasting one in their baseline scenario, so of course the panel of central banking chiefs were hawkish. The Fed’s optimistic economic outlook explains the hawkish language. Our view is a potential economic downturn should ease inflationary pressures, giving the Fed leeway to revisit rate hiking plans.
May Personal Consumption Expenditure
Real consumer spending was stagnant in May after only a modest gain in April as consumers slowed spending habits. The Fed’s preferred inflation metric eased in May, slowing down to 3.8% from a year ago. Services inflation is still running above 5% year over year, but as consumers near the end of their spending splurge, we expect services inflation to ease but it may take a couple quarters before the markets see this category materially improve. The spending splurge is likely nearing the end as consumers released most of the pent-up demand for spending. However, the services economy will likely experience a bit more upside from consumer spending in the near term but aggregate demand will likely cool later this year. As consumer spending cools, we expect inflationary pressures to ease further throughout the balance of 2023. From a global perspective, the domestic inflation environment is materially better in the U.S. than for our international counterparts.
German Economic Outlook
According to recently released data out of Germany, there has been general slowdown in economic activity month-over-month during May. The services and manufacturing sectors, which account for approximately two-thirds of the German economy, failed to post significant growth.
Although the services sector did post slight growth, it was at a slower pace compared to previous months. The manufacturing sector, however, posted a contraction compared to May. These developments combined to send the rate of expansion to its lowest point in four months. Investors should know that disappointing services growth and a contraction of manufacturing activity is signaling a broader slowdown, which is expected to continue into the third quarter.
Initial claims for the latest week came in sharply below economists’ consensus expectation and in addition to the prior week. Meanwhile, continuing claims, which are tallied with a one-week lag relative to initial filings, also were below both the prior week’s levels and economists’ expectation. The labor market is expected to further loosen over the coming months as companies respond to slowing demand, partly driven by the Fed’s tighter monetary policy.
The following economic data is slated for the week ahead:
Monday: S&P Global PMI Manufacturing (Jun), Construction Spending (May), ISM Manufacturing (Jun)
Wednesday: BEA Total Vehicle Sales (Jun), Durable Orders (May), Factory Orders (May), FOMC Minutes
Thursday: Weekly Initial and Continuing Unemployment Claims, Trade Balance (May), S&P Global PMI Services (Jun), ISM Services (Jun), JOLTS Job Openings (May), PMI Composite (Jun)
Friday: Hourly Earnings (Jun), Average Workweek (Jun), Manufacturing Payrolls (Jun), Nonfarm Payrolls (Jun), Private Nonfarm Payrolls (Jun), June Unemployment Report
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