Transcript
Amada Agati:
It’s the dog days of summer, and the market rally is Purple Haze-y! In this month’s Adding Alpha, we cover four key themes for markets as summer winds down .
Let’s start with the first topic on most U.S. investors’ minds right now – trade deals.
Recall that first trade deal with the U.K. which set tariff rates ~10%. Then, the Vietnam deal a few weeks ago came ~20%. So, it was unsurprising to see the Japan/EU deals land in the low-mid teens.
We think U.S. officials are working towards a range-bound set of outcomes, and while tariffs continue to be anti-growth, the market is starting to digest their impact, which seems manageable.
There’s still some Purple Haze swirling amid the ongoing negotiations between the U.S., Canada, and Mexico, and of course, China could be a whole separate #AddingAlpha video, but overall, we seem to be making incremental progress with those key U.S. trading partners.
The worst-case trade policy scenarios, feared by all back in early spring, appear to be off the table. With that backdrop, the market has been able to refocus on the still-solid, hard economic data and underlying fundamentals – in both cases, trends are largely coming in better than expected.
The one variable that we think has the potential to throw cold water on the whole thing, our second key theme, is the liquidity profile of the market.
Since the U.S. debt ceiling was resolved with the budget bill, the Treasury can issue Treasuries again. That should begin to pull liquidity out of markets and into the Treasury’s general account. The recent Treasury Borrowing Advisory Committee report estimated $1T of issuance for 3Q alone.
While liquidity largely acted as a tailwind during the first half of the year, we don’t expect this to be the case in the second half, and this could begin to tighten financial conditions at the same time the Federal Reserve continues to have a bias toward loosening monetary policy.
Speaking of the Fed, that brings us to our third key theme for markets now, monetary policy.
While the Fed held rates steady at its July meeting, as we expected, the decision wasn’t unanimous. Importantly for investors, financial conditions are still easing because forward guidance is still leaning dovish with expectations of, at long last, a 25-bp rate cut in September.
In fixed income, long-term interest rates have been range-bound, with the 30-year UST hovering around 4.7-5.0% for almost three months. Translation: the curve is bear steepening, aka the market is more worried about growing deficits and U.S. debt levels (+ the costs of servicing that debt) over the long run, rather than the potential impact of tariffs on slower economic growth in the short run.
The good news is that the credit cycle isn’t suggesting any major cause for concern now . In fact, July was the strongest monthly level of below-investment grade issuance since 2006!
Last but not least, we have our fourth summer market mover, the latest August payroll report, which somewhat rattled markets.
The # of jobs added missed estimates by ~25,000, but the last two months were revised lower by a whopping 250k! In reaction, the 2-year UST had its biggest 1-day decline in nearly 2 years as investors increased their expectations for a September Fed rate cut. However, the unemployment rate, wage growth & labor participation data remained well-behaved.
That’s all for now, folks. Have a great rest of the summer, and we’ll be back soon with our take on the path forward for earnings, valuations and, ultimately, a crystal ball forecast for market returns.
