Northwestern Mutual

Market Commentary

For the week of Sept. 12, 2016

Both stocks and bonds had their worst day since June’s Brexit on Friday after investors became concerned that central banks, seen as the linchpin to the slow but steady post-recession recovery, might step back.

Key Market Data

The warning signs were Thursday’s decision by the European Central Bank (ECB) to not increase its stimulus spending, and the comments of a Federal Reserve committee member on Friday that it might be time to act, despite the fact that a fellow board member counseled patience on the same day. As a result, all three major indexes tumbled at least 2% on Friday – the Dow Jones Industrial Average shed 394.46 points – and the yield on the 10-year Treasury rose to 1.67%, its highest level since June. The impact on bonds was felt beyond our shores: The yield on the German 10-year issue, which had been negative for most of the summer because of post-Brexit demand, climbed back into positive territory.

When it comes to the Fed raising its benchmark rate for the first time since last December (which was the first time since 2006), it’s not a question of if – the rate will go up – but when. And with little else in the way of hard economic news to divert them, investors have become hyper-focused on the Fed’s meeting on Sept. 20 and 21 though, going into this week, the odds of a hike are still put at only 24% by CRE Group. (A rate increase is considered highly unlikely in November because of the meeting’s proximity to the election, but the odds of a December hike are now 55%; the September and December meetings will be followed by a press conference by Chairwoman Janet Yellen.

One trigger for Friday’s turmoil came when Eric Rosengren, president of the Federal Reserve Bank of Boston, said that, despite some so-so economic data, “A reasonable case can be made for continuing to pursue a gradual normalization of monetary policy.” In addition, investors were focused on a speech by Fed Governor Lael Brainard today, the last day before committee members begin their pre-meeting press embargo. Brainard has been an outspoken dove when it comes to raising the rate, and some speculated that she might use today’s appearance to announce her support for one. At the same time, however, her fellow Governor Daniel Tarullo said on CNBC on Friday, “We have an opportunity to continue to get employment gains in this country before acting,” though he added that he expected a “robust discussion” at the upcoming meeting.

Let the record show

Despite Friday’s angst, a hike in September appears to be a long shot based on recent history. Since 1999, the Fed has increased its benchmark rate at 21 meetings, and ahead of all but two of them more than 90% of the economists surveyed by Bloomberg predicted the Fed move; in every instance the majority had forecast an increase. For the Fed’s upcoming meeting, only 10 of the 59 economists surveyed by Bloomberg – just 17% – expect a 25-basis-point move.

The ECB stands pat; Japan's BOJ is poised

On Thursday, the ECB's President Mario Draghi said that, despite stubbornly low inflation and the impact of the Brexit, the bank would stand pat – for now. The ECB will continue to buy €80 billion a month in bonds through March and could extend that program if need be. Draghi, echoing the communique issued after the Group of 20 meeting in China the week before last, said the best path to fiscal good health would be through economic reforms, long one of his mantras, and more consumer spending. He singled out Germany regarding spending, saying, "Countries that have fiscal space should use it. Germany has fiscal space."

The central bank that seems poised to take further stimulus steps is Japan’s, which also meets next week. This past week, the Bank of Japan’s Governor, Haruhiko Kuroda, set expectations even higher when he said, "There is ample room for further monetary easing in either of three dimensions – quantity, quality and the interest rate – and other new ideas should not be off the table."

The Brexit at home and in Germany

Mark Carney, governor of the Bank of England, told a parliamentary hearing that the post-Brexit recovery in sentiment in Great Britain was partly because of the bank’s “timely, comprehensive and concrete action,” but he warned that the economy still faced a significant slowdown due to the referendum, adding that the bank was prepared to cut interest rates if necessary. The impact will certainly be felt in Germany, however, where the forecast for gross domestic product (GDP) growth in 2017 has been lowered from 1.9% to 1%, with the Brexit knocking about a third of a percentage point off of the earlier estimate. Furthermore, Germany’s share of the European Union budget will reportedly rise by €4.5 billion a year once Britain leaves (the contribution is based on each member country’s GDP).

Oil and Iran

For part of last week, the price of oil rose largely because Iran’s oil minister has apparently agreed to support an effort by the Organization of the Petroleum Exporting Countries to stabilize prices. Until now, Iran, only recently free of sanctions, has refused to cooperate. In other news, the Institute for Supply Management’s Non-Manufacturing Index for August came in at 51.4, down from July’s 55.5 but still above 50, which indicates expansion. The Fed’s Beige Book reported that growth was “modest” or “moderate” in 8 of its 12 districts during the summer. The Labor Department said that job openings rose 4% in July from the month before to 5.9 million; hires and quits were essentially unchanged at 5.2 million and 3.0 million, respectively. Hires were up 1% over the last year, while quits rose 9% from July 2015. Wholesale inventories were flat in July from June. And first-time jobless claims for the week ending Sept. 3 fell 4,000 to 259,000, the four-week moving average for the week ending August 26 dipped 1,750 to 261,250.

A look ahead

Once again, investors will be looking beyond this week to the Fed’s meeting. In the meantime, they’ll weigh economic updates on small business optimism, retail sales, the Producer and Consumer Price Indexes, industrial production and capacity utilization, business inventories, consumer confidence and household net worth.