August is typically a month filled with traders going on vacation and algorithmic program traders causing turbulence in the stock market due to low trading volume. This phenomenon has created a pattern of volatile market actions, characterized by fluctuations in both upward and downward directions. These erratic movements are expected to continue until trading volume picks up or more traders return after Labor Day.
The recent collapse in Treasury yields should prompt the Federal Reserve to cut interest rates by a full 1%. Currently, the Fed funds rate stands 1.5% above the 10-year Treasury rate. If the Fed delays its decision until September 18th, it may prove to be too little, too late, as other central banks such as the Bank of Canada, the Bank of England, and the European Central Bank (ECB) are likely to have already implemented two rate cuts by then. Furthermore, with ongoing layoffs and rising unemployment, which may reach 5% or higher by October, the Fed must take immediate action. The combination of increasing unemployment, declining PCE inflation, and plunging Treasury yields demands a pre-Jackson Hole meeting rate cut.
Many analysts have attributed market volatility to factors like domestic politics or economic statistics. However, the primary driver behind this turbulence, particularly amplified by program trading, is the Japanese carry trade. This practice involves investors selling the Japanese yen to take advantage of the higher yields offered by the U.S. dollar compared to the near-zero interest rates in yen. As concerns about a potential U.S. recession intensify, U.S. Treasury yields have started to decline, causing temporary unwinding of the Japanese carry trade. This, in turn, led to a significant 12.4% drop in the Nikkei 225 Tokyo stock index last Monday, followed by a 10.23% rebound on Tuesday.
Here are some noteworthy market updates and their implications:
– Nearly 90% of the companies in the S&P 500 have reported their second-quarter earnings, and the average earnings growth stands at an impressive 10.9%. The highly-anticipated earnings report of Nvidia on August 28th will mark the grand finale of this season’s earnings announcements.
– Despite the manufacturing sector’s ongoing struggle over the past 21 months, the service sector remains robust, and energy exports continue to propel U.S. GDP growth. The Atlanta Fed currently estimates a solid 2.9% annual GDP growth for the third quarter.
– The Presidential election cycle is gaining momentum, with Kamala Harris joining Donald Trump in promising no taxes on tips. While Harris has not yet matched Trump’s pledge regarding social security benefits, it won’t come as a surprise if she makes more promises. Consequently, the highly anticipated September 10th debate will play a pivotal role, and consumer confidence is expected to rise as candidates promise a multitude of reforms.
– Chinas economic troubles are mounting, negatively impacting Germany due to China being its largest export market for vehicles. Resultantly, the ZEW Indicator of Economic Sentiment, which tracks analysts’ expectations for the next six months, plunged to 19.2 in August. This figure significantly falls below economists’ consensus estimate of 29. Moreover, the recent severe flooding in China has hindered numerous manufacturers of aluminum and specialty components, which likely contributed to the decline.
– Central bankers from around the world will congregate at the Kansas City Fed’s annual conference in Jackson Hole next week. Speculations are rife that they might indicate the possibility of future interest rate cuts. Economies heavily reliant on exports, such as Germany, would benefit significantly from such rate cuts as it would stimulate global demand. Ideally, the outcome of the Jackson Hole meeting would involve central banks signaling additional rate cuts, coupled with the proclamation that inflation has been successfully contained.
– Inflation will be a major focal point this week. On Tuesday, the Labor Department announced that the Producer Price Index (PPI) rose by 0.1% in July, slightly below economists’ consensus estimate of 0.2%. The positive development came from the decrease in wholesale service costs by 0.2%, as these costs had been rising in previous months. However, wholesale goods prices increased by 0.6% in July, primarily driven by higher gasoline prices. Overall, the PPI report indicates a cooling inflation trend.
– The Consumer Price Index (CPI) is also expected to provide favorable insights, with particular attention on shelter costs, especially owners equivalent rent. Fortunately, home prices are currently experiencing their steepest decline in the past two years, especially in popular regions like the Sunbelt, which should contribute to the continued softening of owners equivalent rent.
– There is, however, a notable inflation concern related to energy prices. There are fears in energy markets that Russia’s crude oil exports will continue to decline, potentially exacerbated by Ukraine targeting Russia’s Arctic pipeline. Such developments would prove devastating, potentially causing crude oil prices to soar to $100 per barrel. Recent advancements and disruptions caused by Ukraine in Russian territories, including explosions at a Russian natural gas rig and the Zaporizhzhia nuclear power plant, have further intensified these concerns.
In conclusion, we are currently experiencing the quiet period of summer, characterized by weak trading volume. Notably, small capitalization stocks continue to gradually trend upwards, representing a positive development for broader market breadth and strength. Additionally, Eli Lilly (LLY) has emerged as the new market leader, surpassing Novo Nordisk (NVO) in the weight loss drugs sector. This transition helps alleviate some of the market fixation on the previously dominant “Magnificent 7” stocks.
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