The Story Is Yields 

1.U.S. Economic Growth Is Better-Than-Expected. The latest Atlanta Fed GDP Now model projects +5.8% Q3 GDP expansion, led by manufacturing and consumers. Rather than deceleration and recession, the economy is gaining steam. And while we don’t necessarily expect more than 5.5% growth in Q3, anything above 2.4% represents acceleration from Q2. 

The job market continues to be the engine for the economy, as consumers represent 70% of GDP. The U.S. has never had a recession without unemployment rising more than 0.5% and unemployment remains near historic lows, around 3.5%. 

Chart 1: Quarterly GDP Growth and Persistently Low Unemployment¹ 

ISM Manufacturing data, lower CPI (inflation) data, retail trade and housing starts are components that have led to higher Q3 GDP model projections. Manufacturing appears to be bottoming, there’s momentum in construction spending and retail trade is supported by a recovering auto market. Meanwhile, housing starts, building permits and new home sales are leading indicators for future economic strength. 

Chart 2: Rising Pace of Building Permits, Housing Starts and New Home Sale² 

China, the world’s second-largest economy, is struggling to keep up, marred by problems across its real estate sector. While the U.S. economy is driven by its consumer, China’s economy is concentrated in real estate. Despite the real estate struggles, the Chinese consumer maintains propensity to spend – noted by U.S. multinational companies with significant exposure to China. Wynn (WYNN) noted strength from its Macau locations, Starbucks (SBUX) and Nike (NKE) both beat China sales expectations, and while Estee Lauder’s (EL) report disappointed investors, it saw strength in its luxury beauty category driven by China. 

2. Japan Yield Curve Control Impacting U.S. Yields. Japan’s longstanding yield curve control (YCC) program, which began in 2016 and targets 0% 10-year bond rates, may be unwinding. Japan stood in stark contrast of other central banks, choosing to maintain its easy monetary policy – initially created to stoke inflation and economic activity. As inflation has been pervasive globally since the pandemic, the Bank of Japan (BOJ) has been under pressure to limit its bond buying activity and raise its target rate band because of the devaluing Japanese Yen. 

Chart 3: USD Strengthens as JPY/USD Yield Spread Widens³ 

The BOJ has maintained a rigid 0.5% limit on its 10-year yield. On July 27, the BOJ changed its limit to allow yields to move more freely, up to a maximum 1.0% yield.⁴ Japan’s 10-year benchmark bond yield skyrocketed to a 9-year high after the BOJ announced its initial flexibility on YCC. 

Chart 4: Japan Government Bond Yield at 9-Year High, Surpasses Prior 0.5% Yield Cap⁵ 

A higher Japanese bond yield influences U.S. credit markets: the BOJ is the largest holder of U.S. treasuries, and as Japanese investors sell U.S. bonds in favor of incrementally higher Japanese bonds, U.S. yields should rise. However, any notable exchange of U.S. bonds for Japanese bonds has not happened, as indicated by the U.S. Dollar (USD) continuing to strengthen relative to Japanese Yen (JPY). 

This year’s weakening Yen (-12% since January peak) is a large component to the BOJ’s decision to begin opening its YCC policy. It’s a double-edged sword because higher yielding U.S. treasuries are weakening the low-yielding Yen, but given the BOJ’s position as the largest holder of U.S. treasuries, any significant shift away from U.S. treasuries will push U.S. yields higher via supply, further increasing its spread against Japan’s benchmark yield. 

3. Treasury Supply Influencing the Fed. The Fed is staying data-dependent as economic reports continue to underscore growth and tight labor markets, while inflation improves but persists. The Fed is deciding whether it has done enough tightening as its twelve-month lag effects are taking shape. Consensus among economists is that the Fed cannot take its foot off the gas. 

A spike in Treasury supply after Congress passed its new budget in June, plus the strong economic data, has influenced a second half Treasury yield rally. 

Last week, Treasury bonds sold off throughout the week with the 2-year yield rising 5 bps and the 10-year yield up 10 bps to close the week. The 30-year yield hit its 12-year high to close the week at 4.38%. Municipal bonds sold off across the curve with yields rising 8-12 bps. 

Chart 5: Increased Supply of Treasury Bonds Pushing Yields Higher⁶ 

4. 45th Jackson Hole Economic Symposium. The Fed meets this week in Jackson Hole for its annual economic symposium August 24-26. This year’s symposium is titled, “Structural Shifts in the Global Economy.” We will be paying close attention to the narratives and forecasts from the event. Chair Powell addresses the press on Friday, August 25. 

We expect the Fed to keep up the hawkish rhetoric, moderated by dovish soundbites from select Fed members, and that the Fed will continue to move slowly on rates but maintain a “higher for longer” policy narrative. Whether the Fed hikes rates in either of its next two meetings, we are in the ninth inning. 

5. Analyzing Market Pullback After Strong First Half Returns. The S&P 500 reached its peak on July 31, before pulling back to its current levels (+13.8% year-to-date). While markets have pulled back, this pullback has been driven by NASDAQ composite growth stocks, down -10% from its peak, compared to the Dow Jones Industrials Average Index, down -3% from its peak. 

Chart 6: Growth Outperforming Value Sectors Year-to-Date⁷ 

Over the past year, performance is tight across growth and value. Last year, value outperformed during the second half. We think broadening performance could result in a similar theme this fall. 

Chart 7: Growth and Value One-Year Performance⁸ 

The August pullback is in-line with seasonality; lower trading volumes and valuation contraction among the high-powered growth names that drove the first half performance. The S&P 500 reached its peak concentration on July 18 – when the top ten stocks represented more than 32% of the index. Concentration has since broadened, as investors diversify away from the “magnificent seven” tech stocks that led the first half. 

So far, this broadening has been correlated downward, but pockets of value in equity markets are outperforming growth in Q3. Consumer products, manufacturing industries, aviation and health care are examples of pockets where we are finding value. 

Chart 8: Value Outperforming Growth So Far in Q3⁹ 

Chart 9: Value Has Seasonally Outperformed Growth in September-December¹⁰ 

6. The Week Ahead. 

Earnings – Tuesday: LOW; Wednesday: NVDA, FL, AAP; Thursday: ULTA, DLTR, INTU. 

Economics – Tuesday: Existing Home Sales (July); Wednesday: Building Permits (July), New Home Sales (July); Thursday: Jackson Hole Economic Symposium, Chicago Fed National Activity Index (July), Kansas City Fed Manufacturing Index (August); Friday: Michigan Sentiment (August), Fed Chair Powell Speaks from Jackson Hole. 

Stephanie Link: CNBC TV Schedule 

Return for Selected Indices¹¹ 

Sources

1. FactSet (chart). As of August 20, 2023.
2. FactSet (chart). As of August 20, 2023.
3. FactSet (chart). As of August 20, 2023.
4. CNBC. As of July 27, 2023.
5. FactSet (chart). As of August 20, 2023.
6. FactSet (chart). As of August 20, 2023.
7. FactSet (chart). As of August 20, 2023.

Disclosure 

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