Northwestern Mutual

Financial Markets Commentary For the week of Oct. 10, 2016

The major stock indexes were down for the first time in a month last week after some solid, if not spectacular, economic reports seemed to have persuaded investors that the Federal Reserve will indeed raise its benchmark this year.

As the reality of a messy Brexit took hold, the pound tumbled to a 31-year low against the dollar. The yield on the 10-year Treasury, meanwhile, rose to a four-month high.

The run of positive economic news began early last week when the Institute for Supply Management’s (ISM) Manufacturing Index rebounded from its recent dip into contraction in August at 49.4 and climbed to 51.5 in September; the ISM New Orders Index jumped from 49.1 to 55.1. These prompted Loretta Mester, the president of the Federal Reserve Bank of Cleveland and a “hawk” to say the time had come to raise the Fed’s rate. (At week’s end, the CME Group put the odds of a hike in 2016 at 66%). Then the ISM’s Non-Manufacturing Index came in at 57.1 from 51.4 in August, the largest gain in the index’s almost 20-year history. And on Friday, the Labor Department announced that 156,000 new jobs had been created in September, below the forecast of 170,000, but enough to create positions for first-time entrants to the workforce. The unemployment rate rose from 4.9% in August to 5%, but only because 444,000 people had joined the labor force (those working and those looking for work), a positive sign from the Fed’s standpoint. In fact, over the past year, 3 million people have joined those ranks, the highest yearly gain since 2000 (during the dot.com boom). And the labor force participation rate has risen over the last year from 62.5% to 62.9%, still well below the 66% it was at before the recession, but a marked improvement

In yet another good sign, the four-week moving average for first-time jobless claims for the week ending Sept, 24 was 253,500, its lowest level since 1973.

A harder Brexit?

On Oct. 2, Britain’s Prime Minister Theresa May finally announced that the up-to-two-year process of withdrawing from the European Union (EU) – the Brexit – would begin in early 2017, but she also took a firm stand on controlling the flow of immigrants in and out of her country, a key criterion for EU membership. Over the following week, European leaders pushed back – and pointedly – which contributed to the pound’s drop on Friday (including a 6% dip in less than three minutes that was blamed on electronic trading). France’s President François Hollande took a hard line, saying, “The UK wants to leave but pay nothing. That’s not possible. There needs to be a threat, there needs to be a risk, there needs to be a price.” And Germany’s Chancellor Angela Merkel said that restricting the free movement of people would pose “a systematic challenge for the entire European Union.” It didn’t help when Boris Johnson, Britain’s controversial foreign secretary told The Sun, “Our policy is having our cake and eating it too.” Earlier in the week, Philip Hammond, chancellor of the Exchequer, had presciently warned his countrymen to expect “turbulence” because of the Brexit, and said the government would take “whatever steps are necessary” to protect the economy.

Oil’s rise and fall

The price of a barrel of both United States and Brent crude finally made it past the $50 mark last week in the wake of the recent announcement by the Organization of the Petroleum Exporting Countries (OPEC) that it planned to limit production, but that climb was reversed on Friday when Russia’s Oil Minister Alexander Novak said that his meeting with OPEC in Istanbul next week “will just be consultations.” U.S. crude dipped to $49.81 on Friday (though it gained 3.3% for the week) – according to The Wall Street Journal, the last time it closed the week over $50 a barrel was back in July 2015.

The IMF on trade and Lew on China

In its World Economic Report, the International Monetary Fund (IMF) warned that slowing economic growth could lead to an anti-trade backlash, noting, “It is vitally important to defend the prospects for increasing trade integration. Turning back the clock on trade can only deepen and prolong the world economy’s current doldrums.” The IMF forecast growth in emerging countries at 4.1% in 2016, but only 1.6% in developed countries and also for U.S. gross domestic product (it had been put at 2.1% in July). Then, at the semiannual meeting of the IMF and World Bank in Washington, D.C., China came in for some heat regarding its rising debt load and failure to implement economic overhauls. Treasury Secretary Jacob Lew said, “When you don’t have market forces driving investment, when you don’t have bad investments allowed to fail, you end up with resources allocated in a way that ultimately chokes the future of economic growth.”

In other news, Autodata reported that vehicle sales fell 0.5% in September from a year earlier to a seasonally adjusted annual rate of 17.76 million with 1.44 million vehicles sold last month. Construction spending dipped 0.7% in August from the month before. CoreLogic said that home prices, including distressed sales, were up 6.2% in August from a year earlier, the 55th consecutive year-over-year gain. The trade balance was $40.7 billion in August compared to $39.5 billion in July. Factory orders increased 0.2% in August from the month before; orders for durable goods climbed 0.1%. Wholesale inventories declined 0.2% in August from July. And first-time jobless claims for the week ending Oct.1 fell 5,000 to 249,000, while, as noted, the four-week moving average for the week ending Sept.24 dropped 2,500 to 253,500.

Finally, Mylan will pay a $465 million fine after settling with the Justice Department for overcharging Medicaid and Medicare for its EpiPen.

A look ahead

This week’s reports will include the latest on small business optimism, advance retail sales, the Producer Price Index, consumer confidence and business inventories, as well as the minutes of the Fed’s meeting on Sept. 20 and 21. The coming week is the start of the third-quarter earnings season, with FactSet estimating that earnings will fall 2% from a year earlier.