Is the Fed Behind the Curve

The global sell-off in risk assets (i.e., stocks, commodities, cryptocurrencies, etc.) continued this morning. Investors may have been jolted on news that Japan's Nikkei 225 Index dropped a remarkable 12.4% overnight - its sharpest decline since 1987. The Nikkei is now off by a very sharp 24% since it reached a new all-time high just last month. Though markets are materially lower in many areas of the world, Japan's decline is a distinct outlier and is likely being driven by trades related to currency movements and the expected Bank of Japan response. The story is flipped for fixed income as investors have flocked to bonds. The yield on the 10-year Treasury this morning is down to 3.73% from what had been a level of 4.29% less than two weeks ago (July 24).

In our view, investors should rationally consider the current landscape. Are markets correcting because they may have seen equity market gains come too far too fast? Or are markets falling because of true threats over economic conditions and the possibility of a global recession? We believe, the preponderance of evidence supports the former. The U.S. economy is currently moderating to more sustainable rates, but a near-term recession is not the most likely path ahead, in our view. Even if it were, we believe central banks have ample fire power to lower rates to restimulate activity, if necessary, which should once again entice capital toward stocks.

Investors Appear Concerned the Fed is Behind the Curve

Equity markets have been on a meandering downswing over the last three weeks. Since reaching a closing high of 5667 on July 16, the S&P 500 Index is about 5.7% lower, as of Friday's close. A few negative earnings reports have combined with some weaker than expected economic reports to pressure market expectations. Nevertheless, investors have been growing more concerned that the Fed may be behind the curve in lowering their overnight lending rate, the fed funds rate, as inflation metrics and measures of economic activity have both been moderating at rates that may be uncomfortable. Notably, the previously high flying "Magnificent 7" (Nvidia, Meta, Microsoft, Google, Apple, Amazon and Tesla) stocks have been leading the way lower as softer economic prospects are seen as a threat to the market's lofty expectations for the names. Additionally, growing outlooks for pending interest rate cuts had benefited small-caps and value-oriented issues in recent weeks as they tend to be more cyclical and could benefit from faster than expected interest rate cuts. However, after rising more than 10% in July, the small-cap focused Russell 2000 has dropped 6.4% over the last two trading days (Thursday and Friday).

The July Jobs Report Signaled Weakness, But Several Economic Data Points Remain Strong

Such concerns proliferated on Friday after the Labor Department reported weaker than expected job growth for the month of July. The Jobs Report showed just +114,000 net new jobs to have been created in the month (versus a Bloomberg consensus of +175,000) and with prior month revisions included (of -111,000) the net gain in jobs was essentially flat. The unemployment rate also jumped two-tenths of a percentage point to 4.3% -- the measure's highest level since October 2021 and its highest level outside of the pandemic period (2019 through 2022) since September 2017. Just before mid-day the S&P 500 was down 2.6% but some late-session bargain hunting brought stocks up to a 1.8% decline by the close.

The July Jobs Report joined several other data points that recently signaled some weakness. Initial jobless claims have been meandering higher, and last week's ISM Manufacturing Index for the month of July posted its second weakest reading of the post-pandemic period. Retail sales have also been weak over the last three months, but with some caveats as to why. June retail sales were flat. However, auto sales were a fairly strong, 0.8% higher month-over-month, despite being impacted by the systems outage that plagued roughly half of the nation's auto dealers in late June and gasoline (for which prices declined) excluded. Further, the Commerce Department just reported much stronger than expected real Gross Domestic Product (GDP) for the second quarter (+2.8% versus +2.0% expected).

In conclusion, the economic picture is far from bleak, in our view and we believe the current equity market downdraft is a normal periodic correction similar to the experience of Q3-2023.

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Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.

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