Some carryover from Monday’s rally. Stocks continue to rally after President Trump’s more conciliatory tone on China at the G7 summit, despite conflicting reports on recent conversations with Chinese officials. Although compromise may not come soon as both sides dig in, the fact that more talks are on the calendar is encouraging, while the president’s “job interview” in November 2020 looms large as it may up the pressure to cut a deal. Market volatility and slower economic growth in the United States–and abroad–may increase the chances of another reprieve this fall. Meanwhile, market participants remain focused on falling yields as well as political crisis in Italy, protests in Hong Kong, and a weakening German economy.
Long-term yields drop. Global fixed income investors are still piling into U.S. debt. The 10-year Treasury yield dropped for a fourth straight week last week as the latest bout of trade pessimism weighed on risk sentiment. This morning, the 10-year yield dropped as low as 1.5%, just 14 basis points (0.14%) above a record low close of 1.36%, reached in July 2016. We still believe the 10-year yield’s fair value is much higher than these levels, based on sound U.S. economic fundamentals. However, U.S. Treasuries remain attractive relative to other sovereign debt, so we expect global buying pressure to keep long-term yields around these levels.
Yield curve inversion. Another closely watched part of the U.S. yield curve is squarely in inversion territory, as the spread between the 2-year and 10-year yield has closed negative for the past three trading sessions. Typically, yield curve inversion, when long-term yields fall below short-term yields, is viewed as a signal of oncoming recession, although often with a relatively long lead time (an average of 21 months). Even though we’re discouraged by the yield curve’s shape right now, we see few signs of economic danger ahead. Instead, we think yields are sending a signal to the Federal Reserve (Fed) that monetary policy clearly is still too tight.
Capital expenditures lull continues. Business investment remains a critical component in potentially elongating this economic expansion. Business investment drives productivity, i.e., more output per hour worked, which enables economic growth without sparking unwelcomed inflation. We got a look at business investment yesterday with the durable goods report for July. While headline orders beat expectations (a 2.1% increase compared with 1.2% forecast, per Bloomberg), demand for aircraft drove the increase. Excluding transportation, durable goods orders fell by 0.4% and were flat year over year. Until businesses get clarity on trade, the lull in capital spending may continue, as we discuss on the LPL Research blog. The consumer is admirably carrying the load, but that can only continue for so long.
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