Weekly Commentary | Aug 21, 2022

Macro Picture

The market got a bit tired and snapped a four-week winning streak with the S&P losing 1.2%.  With rates higher, the Nasdaq lost a bit more at -2.6%.  International and EM were down around -3%.  The key was interest rates moving higher with the 10-yr rising back to near 3.0%, a threshold many say is a negative for stocks. 

Oil was down another -2.6% for the week to just below $90 a barrel.  This is good news for inflation.

We had a slew of data this week, the most important came from a few Fed speakers that said things that weren't congruent with a bull equity market.  Firstly, James Bullard of the St. Louis Fed came out and said that we haven't seen the inflation peak yet, in an interview with the Wall Street Journal on Thursday.  

“The idea that inflation has peaked is…not statistically really in the data at this point,” Bullard told the WSJ, while stating that he was likely to vote in favor of another 75 bps increase in the federal funds target rate at the Fed’s next policy meeting.

Meanwhile, ex-Fed governor Bill Dudley warned that we would "almost certainly there will be a full-blown recession.  If we're not in one yet, I think we will be in the next 12 months."

We did have some economic data this week that surprised to the upside with retail sales rising 0.7% (ex-autos and gas).  Industrial production was up 0.6% in the last month, roughly twice what was expected.  Weekly jobless claims ticked lower, against expectations for an increase. 

Interest rates climbed nearly across the entirety of the curve this week with the 10-yr rate rising to 2.95% (it hit 2.98% intraday) from 2.85% last week.  Those high rates are pressuring housing as US homebuilders fell into contraction territory in August with the NAHB index hitting 49 from 55 in July.  This week, Fitch Ratings warned that a severe US housing downturn is possible, though not probable.  

My take:  A recession is coming.  Without one, it is going to be nearly impossible for inflation to get below 4.0% (and probably 5.0%).  As I've said, going from 9.0% to 5.0% is easy.  It's the rest of the path to 2.0% that will be difficult.  Bullard said it will take about 18 months.  If that is the case, the Fed won't be pivoting early next year. 

Now some banks still say that inflation will fall off a cliff in the fourth quarter.  That is true simply because of the base effects (yoy comps).  But again, it will come down but not all the way.  But to get to where we need to be according to the Fed's target, we need to see significant reductions in key economic indicators.  More importantly, it won't happen with the labor market this strong and wages moving higher this fast.  

CEF Market Review

Discounts widened a bit from their tight levels in the last week with taxables going from -2.8% to -3.65%.  Munis also widened quite a bit from -2.2% to -3.4%.  Overall, the CEF average made a fairly significant move going from -3.25% to -4.1%.

Overall, it was a fairly weak week across the income landscape as investors started to assess a more hawkish outcome from the Fed over the next year.  Interest rates rose 12 bps on the week (on the 10-yr) which caused interest-rate sensitive areas of the market to fall.