The equity markets have been on something of a tear in July. For example, the Dow closed higher for 13 straight sessions through Wednesday, before backtracking slightly on Thursday. This is the longest series of consecutive gains since 1987. You have to go back to 1897 to find a time when the Dow was up for 14 days straight.
It was a busy week in terms of economic releases and central bank shenanigans. In general the theme was one of decent growth, moderating inflation, and surprise from the Bank of Japan. Let’s dig in.
Economic Growth
The ‘recession is right around the corner’ crowd are going back to the drawing board. The first estimate for second quarter GDP came in at a solid +2.4%, better than expectations and an acceleration from the +2.0% pace registered in 1Q.
Growth is projected to moderate in the second half of this year, but the projections have been garbage the last couple years.
It’s notably that business investment grew at an annual rate of +7.7% in the second quarter, up sharply from +0.6% in the first quarter. We discussed this dynamic last week.
Inflation Reports
We received a couple reports on inflation. The first was contained in the GDP report. It showed that prices increased +2.2% in the second quarter versus estimates for a +3% increase. As you can see below, this measure is almost back to normal.
The other report came out on Friday. It showed that the Fed's preferred inflation gauge, the personal-consumption-expenditures price index, fell to +3% in June from a year earlier. This is the lowest year-over-year change since March 2021 (dark blue line below).
Taken all, together not a bad set of numbers.
The BoJ Out-hawks the Fed
A number of central banks met this week against the backdrop of resilient growth and moderating inflation. The Fed was expected to be the main event, but there wasn’t much new. They hiked rates by a quarter-point, taking the Fed Funds rate to a 22-year high.
There were minimal changes to its post-meeting statement, and Chairman Powell was non-committal at the press conference. Reading between the lines there’s a decent chance they skip hiking in September, but Powell was very clear that the threshold to cut rates was high. This largely ties in with market pricing at the moment. The betting is on no further rate moves for the rest of the year.
The surprise on the central bank front came from the Bank of Japan. For roughly seven years the BoJ has explicitly targeted the yield on 10-year bonds. In late 2021 and early 2022 the cap was set at 0.25%, then last year the cap was increased to 0.5%, as you can see below.
On Friday the BoJ said they would introduce ‘greater flexibility’ into their policy mix. In practice this means the BOJ will continue to allow yields to fluctuate within the range of 0.5 percentage point either side of its 0% target — but won’t intervene in the markets until rates hit 1%. This effectively expands its tolerance by a further 50bps.
There’s a lot of debate on just how big of a deal this is. Is it the first step towards rate hikes? Maybe the cap will be increased again?
One thing is for sure, the BoJ has been pumping huge amount of cash into the system to cap yields at 0.5% (whenever yields breached this level the BoJ would go into the market and buy as many bonds as needed to drive rates lower). It’s quite possible this liquidity gusher is going to dry up – hence the market correction on Thursday accompanied by a spike in U.S. bond yields.
Why is the BoJ changing policy now? Well, for the first time in eight years inflation is higher in Japan than in the U.S.
(Other) Charts We Found Interesting
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Private wages and salaries increased at a 4.1% annual rate from March to June according to the ECI, that is the slowest pace since the inflationary period began and only a touch above the pre-COVID pace.
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More on the inflation outlook. First, the shelter component of the PCE report has only just flattened out. This matters because shelter makes up roughly 30% of the inflation index.
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But rental prices are now unchanged year-over-year. This should filter through into the shelter piece of the PCE report with a lag.
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Valuation is a terrible timing tool, but where you can find value in the U.S. markets today.
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Global sea-surface temperatures – 2023 is an outlier.
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There are now more realtors in the U.S. than there are single-family homes for sale.
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Mustard flavored Skittles – can’t wait for Halloween!!!
Have a good weekend
Charles Blankley
Principal
Chief Investment Officer
Gemmer Asset Management LLC
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