The data continue to show
That things ain’t so bad, don’t you know
So why do folks feel
The bad stuff is real
With growth steady, though somewhat slow?

Apparently, there is a link
Twixt wage growth and what people think
As real wages fall
They cast a great pall
O’er viewpoints on growth versus shrink

That much anticipated recession seems like it will have to wait at least another quarter or two before landing as yesterday’s 3^rd revision of the GDP data jumped to 2.0% annualized, much higher than forecast, with strength continuing to be seen in both personal and government consumption.  As well, the Initial Claims data fell to 239K, far below expectations and an indication that the steady drumbeat of layoffs may just be slowing down a bit.  It should be no surprise that equity markets rallied on the news, although the NASDAQ was the definitive laggard on the day.  It was not a tech story or an AI story, but a straight up growth story getting investors back into the game.  As today is quarter end, it is also important to remember that many investment managers who had been underweight equities were actively buying to achieve the appropriate window dressing for their clients.

Of more interest, in my view, was the bond market response where yields exploded higher by 15bps in the 10yr as traders priced in even higher for even longer than had been seen before the release.  Here, too, the recession call remains a mirage, or at least very uncertain in the mists.  The 2yr yield rose even further, 18bps, taking the curve inversion to -103bps.  Fed funds futures are now pricing an 85% chance of a rate hike next month, up from a 70% probability prior to the release as pretty much everyone is now on board the rate hike train.

One of the key conundrums is the idea that the Fed continues to tighten policy while equity markets continue to rally.  Historically, rate hikes of this speed and magnitude would have seen a very different reaction, but this time that is just not the case.  For those who remain suspect of the market’s euphoria, there seem to be a number of potential time bombs littering the landscape, notably commercial real estate (CRE) and housing.  In the case of CRE, there are two concerns.  First is that there is a huge overhang of debt that needs to be rolled over in the next 18 months, >$1.5 trillion, which currently has coupons far below today’s interest rate levels.  Adding to the concern is the WFH trend and how many of these buildings, especially office properties in big cities, are not generating the same cash flows as before.  So, higher rates with lower cash flows are a recipe for default and fears are growing that there are going to be many defaults on these outstanding loans.  The fact that the small regional banks have a large proportion of their assets in the CRE class also bodes ill for their ultimate situation.  So far, we have seen several high-profile buildings sell at extremely low valuations and we have also seen landlords walk away from several buildings, with two large hotels in San Francisco the current bellwethers.

Turning to housing, the overriding view has been that the Fed would kill the market given that mortgage rates have risen from ~3% to ~7% alongside higher prices thus more than doubling the average monthly cost of owning a home.  However, two things have conspired to prevent a collapse in this market so far.  First, is the fact that many people who refinanced to a 3% mortgage during ZIRP are simply unwilling to move thus reducing the supply of existing homes on the market, hence keeping prices elevated.  Second is that given the structural reduction in the labor force and the increased demand for construction workers for industrial activity (which has exploded on the back of the Inflation Reduction Act), the housing market remains far more robust than would have been expected.  Add to this the fact that builders are buying down mortgage rates (paying a part of the mortgage so the rate is more like 5% than 7%) and things are working just fine.  Again, it is possible that this time bomb has been defused.

So why the long faces everywhere?  The best explanation I have seen, which apparently has some academic workbehind it, indicates that the evolution of real wages very accurately tracks economic sentiment.  In other words, if real wages are rising, people remain relatively bullish on the economy whereas if they are falling (and they have been negative since April 2021), people tend to have a much more dour view of things.  Politically, if real wages rise it will change the entire population’s view on everything, so if I were in office, it would be the only thing I targeted.  This also explains why inflation is such a major problem for the administration in office.

So, with this as background, perhaps we have a better understanding of what the prospects are for the future, or maybe a roadmap to watch for key signals.

Meanwhile, the data continue to come out fast and the spin doctors are working overtime.  For example, in Europe this morning, CPI printed a tick lower than forecast (5.5% vs. 5.6%) with core CPI doing the same thing (5.4% vs. 5.5%), and people are raving about the better result.  But remember, the target is 2.0%, so there is no evidence they have improved things at all, nor that they are going to be able to slow the tightening process.  However, equity markets across Europe are all higher on the day, most by more than 1%.  Go figure.  The narrative remains the key, and as long as the central banks can control the narrative and get people to believe that things are getting better, markets will respond accordingly.

Bond yields in Europe did not move as far as in the US yesterday but are all modestly higher this morning as well, except for Gilts +8bps on a massive Current Account deficit result generating concerns over the UK’s finances.

As to commodities, oil bounced back toward $70/bbl yesterday and is holding those gains, although not adding to them, but the metals markets continue to suffer with both aluminum and copper falling again today.  Gold, too, is under pressure from higher yields.  Commodities remains the place where recession is seen looming.

Finally, the dollar can best be described as mixed this morning, with a 50:50 split in the G10 although no movers have even made it 0.25% away from yesterday’s close.  In the emerging markets, ZAR (-1.2%) is the lone outlier, falling on the back of the metal market weakness.  However, away from the rand, a split in performance without any outliers is the best description.  However, I must point out that USDCNH, the offshore renminbi, has traded above 7.28 and continues its slow march higher (to 7.50 and beyond!)

On the data front, there is a bunch of stuff today starting with Personal Income (exp 0.3%) and Spending (0.2%) along with core PCE (0.3% M/M, 4.7% Y/Y) at 8:30, then Chicago PMI (43.8) and Michigan Sentiment (63.9) later in the morning.  It seems that the Fed has begun their July 4^th holiday weekend already with no speakers on the calendar until the 5^th.  The market remains very data focused so more strong data should see higher US yields and a firmer dollar, although it depends on which data is strong as to how equities respond.  Strong spending and income data should help, but a high surprise on PCE will not.

And that’s really it heading into the long weekend.  I, too, will take Monday off so no poetry until Wednesday next week, ahead of the NFP report.

Good luck and good weekend

Adf