Capital markets perspective: Cause and expect

Capital markets perspective: Cause and expect


If you’ve been around markets long enough, you start to get a sense of how both the markets and the economy should react to various factors. And when they don’t, it can be a little upsetting. 

Markets have a habit of humbling investors by doing something unexpected at just the exact point that we think we might have them figured out. Today’s environment has provided plenty of reasons for those who watch markets with more than just a passing interest to at least stop and scratch their heads quizzically. 

Let’s start with U.S. Treasuries. There’s no set, scientific formula for when and why treasury prices should firm or fall, but common sense probably holds that when the U.S. dollar is rallying, when equity market volatility is rising, and when the Federal Reserve is hinting that it might actually sit out the next few rate hike opportunities, U.S. treasuries should probably do relatively well on a flight-to-safety bid alone.  

Nope. As I write this on Monday morning, media commentators are making themselves breathless trying to explain why 10-year treasury yields crossed the 5% line for the first time since 2007 (remember, when prices fall yields rise and vice-versa). It’s not necessarily unexplainable – pundits point to a surge in treasury issuance, fiscal profligacy and a host of other factors to explain rising yields – but the fact that rate volatility has spiked and longer-term yields are surging to their highest levels in about 15 years still seems to strike a dissonate chord with everything else going on right now, at least to my ear. 

Next up: the consumer. Again, anyone who presents you with an econometric model guaranteed to predict the direction of retail sales based on macroeconomic factors alone is either fooling themselves or fooling you. Still, just like the head-scratcher that is the current U.S. treasury market, common sense would seem to suggest that when consumers have spent away the final bit of COVID-era savings they stashed during the pandemic, when the tens of millions of student borrowers are suddenly faced with renewed payments after a years-long hiatus, when consumer sentiment is trying to re-test all-time lows set last summer, consumers should probably be pulling back. 

Nope. Last week’s retail sales figure was a blowout: consumers spent 0.7% more in September than they did in August.1 And it wasn’t all gasoline or new cars, either: the ex-gas-and-autos figure was still +0.6% month-over-month and “control group sales” – a category that for some reason is used as the contributing category to GDP growth – was just as strong. 

Again, just like the Treasury market’s goofiness, the September spike in retail sales – as unexpected as it was – is probably not totally unexplainable. Here, you could probably point to recent wage gains and the fact that we’re all just guessing when we say that the COVID savings windfall has in fact been completely spent away. Moreover, renewed requirements to repay those student loans are really kind of squishy: An “on-ramp period” of 12 months aims to “prevent the worst consequences of missed, late, or partial payments, including negative credit reporting”2 has helped mute the impact. Expect for a big spike in early September when interest accruals restarted, student loan remittances to the U.S. treasury have been pretty lackluster.

Despite these and other justifications, last week’s off-the-charts retail spending – just like treasury market wonkiness – might have left you a little perplexed. Which brings us to our last example: employment. We’ve been writing in this space for months now that the job market’s unflinching strength seems at least a little out-of-whack with realities on the ground. Specifically, when new business has dried up, when wage costs and worker demands are rising, and when higher labor and interest costs are pressuring margins, it would be reasonable to expect a slowdown in employment and a rise in layoffs.

Again, nope. Last week’s initial jobless claim number dropped below 200,000 for only the third time this year. While there’s no hard-and-fast rule about where that number has to be before anyone can confidently declare recession, a figure at least twice that high is probably as good a guess as any. Here, justification of that number in the face of stout macroeconomic headwinds probably starts with the idea that businesses who found themselves unable to hire quality candidates fast enough to meet post-pandemic demand are unwilling to risk being caught short if all this recessionary talk eventually fizzles out – a concept we’ve labeled “panic hiring” in these pages. And there’s still the notion that the labor market is usually the last big part of the economy to get the memo when a recession actually does arrive, meaning that real weakness might still be lurking just around the corner. 

In fact, whether you’re talking about treasury yields, retail sales, unemployment claims, or any other datapoint surrounding the macro, such justifications often break down into different forms of the old hoary “this time is different” argument, just recast with an updated frame of reference.  But are things really different? Have the links between things like treasury prices and global uncertainty, between confidence and consumer spending, between employment and new business demand really evolved, or are we just deep into the “uncertain” part of the “uncertain and variable lag” dynamic between tighter monetary policy and economic performance that Jerome Powell so often warned us about when the Fed was still in full-on tightening mode? Only time will tell.  

But for now, at least one old reliable relationship seems to hold: the link between interest rate volatility and equity market volatility. While far from perfect, 20-plus years of history suggests that when rate volatility rises, equity market volatility rises too. Said a little differently, where there is growing uncertainty about rates, there is also growing uncertainty about the direction of equities – to the tune of about half. 

Since August, both are on the rise: The MOVE index, which measures how volatile interest rates are by using options on interest rate swaps to calculate it, has risen by just over 25%.3 Meanwhile the VIX index, which does the same thing for stock market volatility (and is sometimes called the market’s “fear gauge”) is up slightly more than twice that amount. And as anyone who has an investment account can tell you, things just feel a little less unsettled than they did now that autumn has arrived. 

What to watch this week

This week’s economic data is sort of a mixed bag. We’ll get a few more reads of the housing market, but from a “what to watch” perspective, Friday’s income-and-outlays report feels far more important. That report details how much Americans are earning, spending and saving, and could be important as a cross-check to last week’s blowout retail sales report. If the consumer is truly capable of continuing to defy gravity in the future, Friday’s income and outlay report will probably hold clues as to how.

Next down the list is probably Tuesday’s flash PMI reports, a mid-month look at purchasing manager’s surveys that ask business leaders how they feel about near-term trends as well as how they are resourcing themselves for what lies ahead. PMIs do a pretty good job of anticipating turns in the cycle, and they have been on the weaker side for months. Watch this week’s data to see whether recent trends – namely, a slow crawl back toward neutral for manufacturing after months of contraction and a slow descent from growth toward contraction for services – have continued into October. 

Next on the list is probably Friday’s month-end update of consumer sentiment from the University of Michigan. Two weeks ago, the UofM’s survey took a surprisingly big leg down as a result of all the well-known headwinds facing consumers and a surprise resetting (higher) of inflation expectations.

While I doubt it will be immediately impactful to markets, Thursday’s initial read on third-quarter GDP growth could be worth a quick read. Last week’s surprisingly strong retail sales data for September, together a big upward revision of August’s number, hints that Thursday’s report could be a strong one. Of more immediate interest, though, will be the PCE inflation numbers imbedded in the report: Recent reads (not least of which was the re-rating of consumer inflation expectations inside the UofM’s mid-month update a few weeks ago) suggest that inflation has not yet gone quietly into the night. While strong GDP growth could make for happy reading, PCE inflation has the potential to play spoiler to the markets.

Finally, third quarter earnings season continues to heat up this week, with a number of top-shelf releases from Microsoft, Alphabet/Google (both on Tuesday) and Amazon (Thursday) representing the “magnificent seven.” Automakers GM (Tuesday) and Ford (Thursday) could provide insight into the ongoing labor dispute with the UAW, while Friday’s “big oil” day could put additional context around one of the key worries surrounding the inflation discussion – crude oil prices. In between all that is a miscellaneous collection of earnings reports that could shed light on things like consumer demand (Coca-Cola, Mastercard), industrial/manufacturing (3M, Boeing) and tech (IBM, Intel). After the big banks led a strong start to the season a week and a half ago, trends have been a little more mixed. Last week’s reports featured a big miss and downbeat guide from Tesla, fears of spillover into travel demand from United, and weak outlooks from several transport and logistics companies. While trends so far have been far from awful, a significant firming of earnings results would go a long way toward reassuring markets. 





[3] Bloomberg, ICE BofA and Empower Investments calculations

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Tom Nun, CFA


Tom Nun, CFA, Portfolio Strategist at Empower, works alongside teams overseeing portfolio construction, advice solutions, portfolio management, and investment products and consulting.

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