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Financial Markets Commentary For the week of July 02, 2018

Key Market Data

06/22/2018 06/29/2018 One Week Change YTD One Year
S&P 500 Index 2,754.88 2,718.37 -1.33% +2.65% +14.54%
MSCI EAFE Index 1,980.44 1,958.64 -1.10% -2.40% +6.69%
Barclays Capital U.S. Aggregate Bond Index 2,006.38 2,013.28 +0.34% -1.62% -0.54%
10-year Treasury Note Rate 2.896% 2.861% -3.5 basis points +45.4 basis points +69.4 basis points

In a tumultuous quarter during which the words “trade war” suddenly figured prominently in the lexicon and psyche of every American investor, the three major U.S. indexes nonetheless all finished up. The Nasdaq led the way, notching its eighth consecutive quarter in the black and rising 6.6 percent, while the S&P 500 and the Dow rose 3.4 percent and 1.2 percent, respectively. For the first half of the year, the Nasdaq advanced 9.3 percent and the S&P 500 added 2.6 percent, but the Dow is still down 0.7 percent for 2018 after a weak showing in the first quarter.

As for bonds, the yield curve – the difference between the interest rate on short- and long-term U.S. Treasurys – continued to narrow, coming closer than at any point since 2007, just before the Great Recession. James B. Bullard, President of the Federal Reserve Bank of St. Louis, said he’s concerned about the flattening of the yield curve and that the Fed might have to slow the pace of rate hikes to keep it from going negative. Bullard, who has argued for caution when it comes to the pace of hikes, noted that an inverted yield curve has historically been a reliable indicator of impending recession, adding, “I would see the yield curve inversion as a key near-term risk for the Fed.”

Trade war talk

Last week’s headlines were dominated by trade-war talk, which also drove the market – a comparatively quiet day on Friday led to a rebound, but all three indexes were still down for the week. During the week, Canada joined Mexico and the European Union in imposing retaliatory tariffs on U.S. exports because of our tariffs on steel and aluminum, with Foreign Minister of Canada Chrystia Freeland saying, “We will not escalate, and we will not back down.” As an editorial in The Wall Street Journal observed, the trade war has been an “abstraction so far,” but now “the casualties are starting to mount.” The most headline-grabbing news of the week came from an American company – Harley-Davidson – reacting to the EU’s tariffs, and President Donald Trump’s response. Harley said it would build a factory in Europe, its second biggest market, to offset the new tariffs, which were increased to 31 percent from 6 percent. The president accused Harley of having “surrendered” and threatened that it will be “taxed like never before” if it moves ahead with its plan. At the end of the week, General Motors (GM) submitted a letter to the Commerce Department co-signed by Toyota warning that proposed tariffs on car imports could raise the price of cars, cost jobs, and result in “a smaller GM.” In addition to using foreign parts, 36 percent of GM cars sold in the U.S. were imported, as were 54 percent of Toyota’s, according to LMC Automotive. Hearings about the proposed tariffs on cars and auto parts have been scheduled for July 19 and 20.

China, meanwhile, is feeling the impact of a real and projected trade war in several ways. Early last week, the Chinese government said it would reduce the amount of money banks need to hold on deposit by half a percentage point on July 5, freeing $100 billion to help small businesses and companies in deep debt. China’s President Xi Jinping told a group of investors that China was ready for a fight: “In the West you have the notion that if somebody hits you on the left cheek, you turn the other cheek. In our culture, we punch back.” As evidence, when the next round of tariffs against China goes into effect this Friday, totaling $34 billion in goods, China will respond with $34 billion in tariffs on U.S. exports. Still, by the end of last week, the yuan had taken a beating at the hands of the dollar and the Shanghai Composite Index had fallen into bear territory. China was also in the news because of the back-and-forth coming from the White House about curbing that country’s investment in American tech companies, as well as exports of American technology, all of which helped the Nasdaq fall 2 percent for the week.

Q1 gross domestic product (GDP)

The government’s third estimate for first-quarter growth came in at 2.0 percent, below the forecast of 2.2 percent and down from the original estimate of 2.3 percent. The revision was largely the result of reduced consumer spending, which fell to its lowest level since the second quarter of 2013, up just 0.9 percent (compared to 4 percent for the fourth quarter of 2017). However, the first quarter of the year has typically been slow since the recession ended – GDP was up 1.4 percent in 2017 and 1.1 percent in 2016. Thanks in part to the impact of the tax cuts and the low unemployment rate, the Federal Reserve Bank of Atlanta GDP model now estimates that second-quarter growth will be 3.8 percent.

Inflation on the rise

The personal consumption expenditures (PCE) price index was up 0.2 percent in May from April and 2.3 percent for the year, the biggest year-over-year gain since 2012. The Fed’s preferred gauge for inflation, the Core PCE price index (less food and energy), was also up 0.2 percent month over month and climbed to the Fed’s target of 2 percent for the year, also for the first time since 2012. Personal spending increased 0.2 percent in May and personal income rose 0.4 percent.

The price of oil climbs on Iran news

Oil prices rose last week after the White House said that it will impose sanctions on any country that buys oil from Iran starting on Nov. 4. Countries that violate those sanctions could be stopped from selling any products in the U.S.

In other news

Sales of new homes rose 6.7 percent in May from April to an annualized 689,000; sales increased 14.1 percent from a year earlier. However, the National Association of Realtors said that pending home sales were off 0.5 percent in May and down 2.2 percent from May of 2017. The S&P CoreLogic Case-Shiller home price index was up 6.6 percent in April from a year earlier compared to 6.7 percent in March. The University of Michigan’s consumer sentiment index was 98.2 in June compared to 98 in May, but down from a preliminary reading of 99.3 for June. First-time jobless claims for the week ended June 23 climbed 9,000 to 227,000; the four-week moving average rose 1,000 to 222,000.

A look ahead

This week’s updates will include the latest on construction spending, the Institute for Supply Management’s manufacturing and nonmanufacturing indexes, capital and durable goods orders, vehicle sales, consumer comfort, the trade balance and the unemployment rate, expected to remain unchanged at 3.8 percent. The Fed also will release the minutes of its June meeting, at which it raised its rate for the second time this year.

Have a happy and healthy 4th of July!