New Highs Despite Rising Trade Tensions
It was a mixed week for the U.S. equity indexes, but the S&P and Dow did manage to hit new highs. For the week the S&P added +0.9% but small-caps and the NASDAQ lost -0.6% and -0.3% respectively. The overseas markets performed much better for a change. Japan gained +3.4% while the EAFE was up +2.8% and the emerging world +3.0%. A softer dollar for the first time in a while sure helped matters for international investors.
Interest rates backed up despite some soft housing numbers and the 10-year closed above 3% just ahead of next week’s Fed rate hike. Intermediate-term government bonds lost -0.5% while long-term bonds were down -1.2%. High-yield and bank loans managed to gain +2.4% and +0.2% respectively.
The rally in stocks came despite trade tensions between the U.S. and China ratcheting higher once again. President Trump said that starting on Monday another $189bn of imports will be hit with a 10% import duty. This will increase to 25% at year-end. The Chinese promised to retaliate on $60bn of American exports. The chart from The Economist below shows how the universe of Chinese imports impacted by tariffs has grown over the last few months to cover about $235bn of imported goods.
Interesting, smartwatches and Bluetooth devices were removed from the latest list at the last minute. Apple must be pleased!!
Goldman Sachs, estimates that the 10% tariff rate will boost inflation by only around 0.03% next year, and the increase to 25% by a further 0.05%.
But there are chances there is more to come. From The Economist:
“In his announcement on September 17th Mr Trump threatened to hit another $267bn-worth of Chinese imports if China retaliated against his latest tranche of tariffs. For their part, the Chinese show little sign of backing down, and have promised to use fiscal policy to soften any domestic blow.
Although they are running out of American exports to target, they have other ways to fight. On September 17th, for example, reports emerged of a Chinese official musing about China repeating its trick of imposing export restrictions on raw materials that American manufacturers depend on.”
Housing Softens – Lumber Tumbles
There’s little doubt growth this quarter should be solid – anywhere between +3% to +4%. But as we noted last week, housing is softening. There was more confirmation this week. Existing home sales were flat in August, confounding expectations for solid growth. After all, sales in August are generally solid before the kids go back to school. If anything, over the last few months a modest downtrend in sales has developed, as you can see below.
The key stat in the existing homes sales report was the inventory number. Inventories grew year-over-year for the first time since 2015 (blue line below).
As we noted last week, this isn’t the end of the world. A hot market is simply slowing. We saw something similar in 2010 and 2014/2015. It is a natural response to mortgage rates hitting the highest level since 2013.
One consequence of this is home construction is slowing. This means less demand for lumber. Throw on top of this the trade concerns noted earlier, and lumber prices have really struggled the last few months – they are down close to 50% from the May 2018 high.
But So What?
So, does the softening in housing mean the Fed strikes a cautious tone at next week’s meeting?
The Fed has a dual mandate – maximum employment and stable prices (with a nod to moderate long-term interest rates thrown in for good measure).
If anything, the Fed probably welcomes a softening in housing if it serves to keep price pressures under control. They are almost certainly more focused on the labor market at the moment. This week initial unemployment claims fell to their lowest level since 1969, as you can see below.
This fact alone almost guarantees a hike next week and another in December. After all, wages are growing at the fastest pace since 2009. This reinforces the view that the economy is operating at least at full employment, if not beyond.
If anything, the risk next week is the Fed strikes a more aggressive tone. As Tim Duy noted on Friday:
“Fed Chairman Jerome Powell and his fellow policy makers remain primarily focused on a domestic economy that holds substantial momentum as the fourth quarter approaches. At best, the message from the Fed is neutral relative to the June…report and press conference. The risk, however, is that the Fed’s message is on the hawkish side, including an upward shift at the lower end of rate projections that doesn’t necessarily imply a faster pace of hikes, but more confidence that the gradual pace of increases will extend deep into 2019.”
Next week’s hike will also mark a significant milestone. The real Fed Funds rate has been negative for 124 consecutive months, the longest run in history (the real rate is defined as the Fed Funds Rate minus inflation – the blue line below). A quarter point hike on Wednesday will finally push the real Fed Funds rate to zero for the first time since 2008.
Six more quarter point hikes to go to get back to average!!
Have a good weekend.
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