Equity markets continue to show remarkable resiliency given the clear slowing of the global economy and the uncertainty surrounding the trade conflict. The S&P 500 Index rose for the second-straight week, climbing to within 2% of its all-time high. The completion of the market has shifted, however, with low volatility and high yielding sectors (health care, utilities and real estate) strong over the past month, while high beta cyclicals (energy, communication services and industrials) have lagged.
The next two weeks will place a spotlight on the two primary market drivers: The Fed and trade. There is an FOMC meeting this week, and while the odds of a rate cut at this meeting are less than 20%, the commentary will be closely watched for a signal on the July meeting. Economists would view the dropping of the word “patient” from the commentary as such a sign. The odds of a cut at the July meeting are currently 83%, up from 25% a month ago. The highly-anticipated G-20 meeting is held the following week and is expected to include a meeting between Presidents Trump and Xi around the trade war. Commerce Secretary Wilber Ross downplayed prospects of a major deal, though it could set the groundwork for future discussions.
Inflation data remains below the Fed’s target of 2%, with headline CPI at 1.8% from a year ago. The sluggish result is evidence that the tariff escalation between the U.S. and China has not found its way to the consumer but is being absorbed by the supply chain. This is likely to impact corporate profit margins. The average inflation rate for the past nine years has been 1.8%, suggesting that the Fed has flexibility to drive growth. Notably, inflation expectations have moderated considerably over the past year. The current expectation for inflation over the next five years is 2.2% versus 2.6% last June. The last three times inflation expectations were lower than the Fed Funds rate, the FOMC cut rates.
Consumer: The consumer appears to be shrugging off the trade war to date. Retail sales rose 0.5% from April and 3.2% from a year ago with 11 of the 13 areas measured showing growth. Consumer sentiment remains near a historic high with a June reading of 97.9. Falling interest rates are boosting large-ticket purchases with mortgage applications surging to the highest level since 2016, while refinancing applications are up 47% and new home applications are up 10%. Auto sales also showed strength. Expectations for second-quarter growth are beginning to improve with the Atlanta Fed’s GDPNow model currently forecasting 2.1%, up from 1.1% expected a month ago. The current consensus of economists is for 1.9% growth, down from 3.1% in the first quarter.
Global Economy: While the U.S. consumer remains healthy, there are clear signs of slowing global growth. Global manufacturing PMI fell to 49.8 (below 50 indicates contraction), the lowest since 2012. The global services PMI of 51.6 was a three-year low. This is a clear indication that the trade uncertainty has caused a wait-and-see approach by corporate managers. If no trade resolution is reached, several economies could re-enter recessions, similar to 2012 and 2013.
What to Watch
In addition to the FOMC meeting on Wednesday, there are some notable economic releases this week. Data includes housing starts on Tuesday, leading indicators on Thursday, and PMI surveys and existing home sales on Friday.