weekly Market Update: August 21, 2023
The U.S. inflation situation remains unsettled. True, the July increases for the Consumer Price Index (CPI) and the core-CPI, which excludes the food and energy components, moderated some on both a sequential and year-to-year basis. However, July producer (wholesale) prices came in stronger than anticipated, and inflation in the labor market, as measured by the average hourly wage, rose last month.
Wall Street is uncertain about what this means for the Federal Reserve ahead of its next monetary policy decision. Although the majority thinks the central bank will pause next month, the possibility of another quarter-point hike to the federal funds rate, to 5.50%-5.75%, remains on the table. This uncertainty, along with signs pointing to the Fed keeping interest rates elevated for an extended stretch, possibly to late 2024, has pushed Treasury market yields higher and pressured higher-growth equities.
The Fed in its battle to tame inflation must guard against overtightening the monetary reins and putting additional pressure on the financial system. Concerns about the health of U.S. regional banks resurfaced after a major rating agency downgraded its credit ratings on several lenders. Regional banks remain vulnerable to nervous depositors, risks from higher interest rates, and a weakening commercial real estate market. This has prompted many banks to cut back on lending, which is not an ideal backdrop for future growth.
Consumers are still opening their wallets. This was evident in the better-than-expected 0.7% retail sales advance in July. However, this has been accompanied by ballooning credit card balances. The Federal Reserve Bank of New York reported that credit card balances rose to $1.03 trillion in the second quarter. This comes at a time when student loan repayments are set to resume, putting additional stress on household budgets. If the consumer, which has been the backbone of the U.S. economy in recent years, is eventually forced to cut back on spending, domestic growth would probably be compromised.
Conclusion: Equity market volatility has picked up, which is not overly surprising as valuations were stretched coming into August and September, two historically weak months for stocks. Given this environment, we continue to recommend a portfolio consisting mostly of high-quality stocks.