After a sharp decline bottoming on Aug. 5, new data drove a strong US stock rally last week \u2014 actually the best week this year.<\/p>\n\n\n\n
We believe the US economy will avoid recession and re-accelerate later this year\/early next year, as wages improve and monetary policy easing starts.<\/p>\n\n\n\n
Federal Reserve Chairman Jerome Powell is speaking at the Jackson Hole Economic Symposium and may provide color on easing plan.<\/p>\n\n\n\n
A theme I keep coming back to this summer is \u201creversal of fortune.\u201d I think it accurately describes the last several weeks. Markets\u2019 perceived risk of a US recession has fallen almost as quickly as it rose thanks to recent data. US retail sales rose 1.0%, which was much higher than expected.1<\/a><\/sup> Walmart, a bellwether consumer retailer, reported better-than-expected results. Both the number of transactions and the average amount customers spent during those transactions was higher than it was during the same quarter last year. In addition, US initial jobless claims eased to 227,000 last week, which was below expectations, from 234,000 the previous week, which also was lower than expected.)2<\/a><\/sup> And consumer sentiment rose for the first time in five months in the University of Michigan Survey of Consumers.3<\/a><\/sup> It seems clear that continued progress on disinflation is helping.<\/p>\n\n\n\n Markets are reflecting that with a very strong rally for US equities last week \u2014 actually their best week this year \u2014 as well as a strong global equity rally. The VIX has fallen dramatically from its August 5 peak. High yield spreads have tightened by more than 60 basis points since the August 5 market bottom.4<\/a><\/sup> Markets are clearly breathing a sigh of relief.<\/p>\n\n\n\n But that doesn\u2019t mean that cracks aren\u2019t forming. One question asked in the monthly New York Fed Survey of Consumers is what the respondent believes is the probability they\u2019ll miss a minimum debt payment in the next three months. In the most recent survey released last week, the mean probability of missing a minimum debt payment over the next three months rose to 13.29%, the highest level since 16.15% in April 2020 in the face of pandemic shutdowns.5<\/a><\/sup> We\u2019ve heard from countless companies that US consumers \u2014 especially lower income consumers \u2014 are under increasing pressure. Home Depot\u2019s CEO recently explained, \u201cDuring the quarter, higher interest rates and greater macroeconomic uncertainty pressured consumer demand more broadly, resulting in weaker spend.\u201d6<\/a><\/sup> And Bank of America\u2019s CEO urged the Federal Reserve (Fed) to cut rates soon because of the pressure on consumers, \u201c\u2026in our consumer base of 60 million customers spending every week, what you’re seeing is they’re spending at a rate of growth of this year over last year, for July and August so far, about 3%. That is half the rate it was last year at this time. And so, the consumer has slowed down. They have money in their accounts, but they’re depleting a little bit. They’re employed, they’re earning money, but if you look at \u2014 they’ve really slowed down\u2026\u201d7<\/a><\/sup><\/p>\n\n\n\n In short, our base case from our mid-year outlook holds thus far. We think the US economy will be able to avoid recession and re-accelerate later this year\/early next year, propelled by improving real (inflation-adjusted) wage growth and the start of easing monetary policy. But avoiding a more serious economic downturn is predicated on the Fed acting quickly enough. We already have improving real wage growth and now we\u2019re waiting for the start of rate cuts. We need rate cuts to start soon \u2014 that\u2019ll be key to our base case scenario playing out.<\/p>\n\n\n\n It\u2019s not just the US. Japan is also experiencing a reversal of fortune of sorts. Japanese equities experienced a large sell-off in the aftermath of the Bank of Japan’s (BOJ) decision to hike rates on July 31, which caused the Japanese yen to strengthen materially relative to the US dollar. But as I mentioned last week, on August 7, BOJ Deputy Governor Uchida pledged the BOJ would not hike rates again if markets are unstable. The Japanese yen (JPY) modestly weakened. Japanese equities also rallied, although I believe it was driven not just by a weakening yen but by strong economic data. For example, last week it was reported that Japan\u2019s gross domestic product (GDP) growth for the second quarter was higher than expected. It\u2019s important to note that private consumption items, especially durable goods, rose in the second quarter on higher wage increases. My colleague Tomo Kinoshita believes that with various policy supports, including tax cuts and revival of fuel subsidies, solid consumption growth is likely to be sustained in the short term. It\u2019s that pick up in consumption growth that appears to have helped domestic demand-related stocks after the early August stock market correction.<\/p>\n\n\n\n The Japanese yen carry trade, which unwound disruptively after the surprise BOJ hike, has rebounded in popularity in recent days. I anticipate, however, that the US dollar and other major currencies will weaken relative to the Japanese yen in the coming months as the Fed and other central banks ease. That doesn\u2019t mean Japanese equities will necessarily experience losses, given our expectation of sustainable economic growth. A strong JPY could provide a headwind for Japanese equities, but it\u2019s not insurmountable. Continued positive economic data could power Japanese equities higher, even in the face of political uncertainty, given the resignation of Japan\u2019s prime minister.<\/p>\n\n\n\n Then there\u2019s the UK. It was less than two years ago that Prime Minister Liz Truss and her Chancellor introduced a controversial budget that reflected the economic challenges facing the UK, and the UK experienced a gilt yield crisis. Today, the UK is enjoying its success in driving down inflation near the Bank of England\u2019s target, while unemployment for June clocked in lower than expected at 4.2%.8<\/a><\/sup> The outlook is positive. My colleague Paul Jackson has pointed out that UK real wage growth is higher than in the US, as is the UK household savings ratio (which is close to historical lows in the US) and that real retail spending is now recovering in the UK.9<\/a><\/sup> He argues that the UK consumer (and economy) may even be in better shape than in the US given the increased pressure on the US consumer. And the Bank of England has already begun to cut rates, which should provide a psychological boost. Markets have reflected an improved outlook for UK equities, with the MSCI UK Index up more than 3% last week.10<\/a><\/sup><\/p>\n\n\n\n This week, we\u2019ll get the minutes from the July Federal Open Market Committee (FOMC) meeting. That\u2019ll be important and could create short-term volatility as markets get a greater sense of what the Fed was thinking in late July. Its importance, however, will be short-lived as it\u2019s very backward-looking and we’ll soon get some forward-looking guidance. Attention will turn to the start of the Jackson Hole Economic Symposium and Jay Powell\u2019s speech there at the end of the week. Historically, the Fed has taken advantage of Jackson Hole to introduce policy shifts (or even new policies), so I think we will get more color on the Fed\u2019s plan for easing. This will be \u201cMust See TV\u201d for market strategists and investment professionals, especially given the dramatic impact that monetary policy has had on markets in recent years.<\/p>\n\n\n\n In conclusion, we have seen a lot of reversals of fortune in the past several months, and we\u2019re likely to see more in the coming months. Taking a step back, I\u2019ve been watching markets since 1995, and there has been no shortage of twists, turns, and surprises over the years. I\u2019ve also learned that base case scenarios rarely, if ever, play out exactly as we anticipate.<\/p>\n\n\n\n —<\/p>\n\n\n\n Originally Posted August 20, 2024<\/p>\n\n\n\nStrong US and global rally<\/h2>\n\n\n\n
Some US cracks<\/h2>\n\n\n\n
Base case: Avoid US recession<\/h2>\n\n\n\n
Japan reversal<\/h2>\n\n\n\n
UK: Improved outlook<\/h2>\n\n\n\n
Looking ahead: A big week<\/strong><\/h2>\n\n\n\n
The week ahead<\/h3>\n\n\n\n
Date<\/strong><\/th> Event<\/strong><\/th> What it tells us<\/strong><\/th><\/tr> August 19<\/td> Bank of Canada Senior Loan Officer Survey <\/td> How economic or financial conditions are affecting business lending.<\/td><\/tr> <\/td> People\u2019s Bank of China Loan Prime Rate <\/td> Benchmark lending rate.<\/td><\/tr> <\/td> Reserve Bank of Australia Meeting Minutes <\/td> Gives further insight into the central bank\u2019s decision-making process.<\/td><\/tr> <\/td> Korea Consumer Confidence<\/td> Tracks sentiment among consumers.<\/td><\/tr> August 20 <\/td> Eurozone Consumer Price IndexCanada Consumer Price Index<\/td> Tracks the path of inflation.<\/td><\/tr> August 21<\/td> FOMC Meeting Minutes<\/td> Gives further insight into the central bank\u2019s decision-making process.<\/td><\/tr> <\/td> Australia Purchasing Manufacturing Indexes
Japan Purchasing Manufacturing Indexes <\/td>Provides an indication of the economic health of the manufacturing and services sectors.<\/td><\/tr> August 22<\/td> Jackson Hole Economic Symposium begins
<\/td>Annual economic policy symposium hosted by the Federal Reserve Bank of Kansas City central bankers, policymakers, academics, and economists from around the world.<\/td><\/tr> <\/td> Eurozone Purchasing Manufacturing IndexesGermany Purchasing Manufacturing IndexesIndia Purchasing Manufacturing IndexesUK Purchasing Manufacturing IndexesUS Purchasing Manufacturing Indexes <\/td> Provides an indication of the economic health of the manufacturing and services sectors.<\/td><\/tr> <\/td> Japan Consumer Price Index<\/td> Tracks the path of inflation.<\/td><\/tr> <\/td> UK Consumer Confidence <\/td> Tracks sentiment among consumers.<\/td><\/tr> August 23<\/td> Canada Retail Sales<\/td> Indicates the health of the retail industry.<\/td><\/tr> <\/td> US New Home Sales<\/td> Indicates the health of the housing market.<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n