Interest Rates. Interest rate volatility increased in early July, with Treasury yields spiking and then round-tripping back to their starting point. The volatility is occurring as the market attempts to figure out where yields should settle, with the recent volatility attributed to investors initially frontrunning expectations for a hot June inflation report and then reversing course when inflation came in below consensus (see next section). Looking forward, yields could remain volatile.
Inflation. Headline CPI rose +0.2% m/m in June, an increase from May's +0.1% and slightly below the consensus estimate of +0.3%. Core CPI also rose +0.2% m/m, which was the slowest pace since August 2021, with shelter and vehicle insurance contributing to the rise. For the 12 months ending June, headline CPI rose +3.0% y/y, the smallest increase since March 2021. The report suggests inflation is easing and aligns with our U.S. CPI Leading Indicator's forecast for a further decline driven by used vehicle prices and reduced shelter and food costs.
USD. June's inflation report relieved some pressure on the Fed, causing Treasury yields to decline and USD to weaken to a 52-week low. Our USD Technical Indicator has forecast a weaker USD trend this year, but it now suggests the trend is losing steam. If economic data deteriorates in 2H 2023, the trend could reverse and strengthen the USD. A stronger USD could cause tighter financial conditions and hurt U.S. companies' international revenue, but it could also help ease inflation.
Bank & Credit Card Earnings. Banks are reporting higher revenues as interest income rises, but management teams are forecasting 2H 2023 margin pressure due to increased interest expense on deposits. On a related note, weak non-interest income (i.e., investment banking & trading revenue) and rising loan loss provisions, particularly in the office space, pose margin challenges. The reports suggest smaller regional banks face a tough 2H 2023 with widespread margin pressure and the risk of loan write-downs.
Retail Sales. Retail sales and food services spending rose +0.2% m/m in June, down from May's upwardly revised +0.5% and below the consensus estimate of 0.55%. For the 12 months ended June, retail sales rose +1.5% y/y, a continuation of the broad trend of slowing growth. Spending was mixed across categories, with spending on furniture, clothing, electronics, and online shopping increasing and sales at grocery stores, gas stations, hardware stores, and sporting goods decreasing. Dining out at bars and restaurants was flat.
Housing. Homebuilder sentiment improved for a 7th consecutive month in July as low existing inventory offset concerns about rising mortgage rates (Figure 5 ). After rising in May, the pace of building permits and housing starts both contracted in June, with broad weakness across regions (Figure 6 ). Existing home sales fell to a 4,160K annualized pace in June from 4,300K in May, matching lows from November 2022 through January 2023. The data shows housing remains subdued as high mortgage rates limit existing home inventory and decrease affordability.
Manufacturing. Industrial production declined by -0.5% m/m in June, continuing the downward trend from May (-0.5%). Over the past 12 months, industrial production contracted by -0.4% y/y, the first decline since February 2021 (Figure 3 ). Most major groups experienced declines, including consumer durables, manufacturing output, oil and gas drilling, and utility output. The report provides more evidence that higher interest rates are starting to impact economic activity.
Key Takeaways: Data remains favorable and the anticipated recession still eludes us, at least for now. Market appreciation this year has reflected investors' digesting of the improvements. At this juncture we remain cognizant of valuations in asset classes and sectors, and on individual portfolio risk allocation.
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