MV Weekly Market Flash: The...
Two things of note happened this past Wednesday. The first was yet another surge in bond yields, with the 30-year Treasury rate, at 5.48 percent, the highest it has been since 2004. Treasury yields all the way down to the 5-year note are now sitting above five percent. We have been talking a lot about bonds in recent commentaries, mostly because right now, what is happening in the global bond market is the most important thing happening anywhere in the financial world.
The second thing that happened on Wednesday was an economic report called the Purchasing Managers Index, which serves as a useful proxy for measuring economic activity across a broad range of manufactured goods and services. Wednesday’s composite US PMI report came in scorching, with both the manufacturing and the services components well ahead of economists’ expectations. A PMI score above 50 represents expansion, while anything below that signifies a contraction. The composite PMI of 58.4 was well into expansion territory.
Growth as far as the eye can see
Those two events on Wednesday are related. Bond yields, which had been mostly quiescent earlier in the week, took off following the release of the PMI report as investors factored “hotter than expected growth” into their evolving models for Fed action on rates. Odds of another rate hike at the next Fed meeting went up to 70 percent – which is notable in part because the next FOMC meeting is on October 28, and that in turn is less than one week before the midterm elections. In the past, the Fed has generally been reluctant to take significant policy action close to major elections, but unfortunately for the policymakers, the economy doesn’t move to the dictates of an electoral calendar.
Stepping back from the minutiae of this week, we couldn’t help thinking back to all the predicted recessions of the past few years that never came to pass. Back in 2022, when the Fed began its monetary tightening program to bring down inflation, a recession seemed to be almost unavoidable. We put the odds of one as more likely than not in our annual outlook at the beginning of that year. But lo and behold, it never materialized. Household debt went up, as did prices at the grocery store and pretty much everywhere else, and consumer sentiment turned as bleak as it has ever been. But the growth kept coming. The Organization for Economic Cooperation and Development (OECD) published its latest quarterly report this week. Its title, which seems very appropriate, is “Weathering Successive Shocks.” War, debt, extreme phenomena of nature – the global economy has kept on growing despite all of them.
Consumers and data centers
The AI infrastructure boom, of course, has been a centerpiece of this structural growth story. And there is concern aplenty among observers that this intense reliance on something that has not yet proven conclusively how useful it will be to the economy is dangerous. Indeed there is some peril there, and not least because much of the spending on AI now is taking the form of debt issuance, and that debt is another reason why interest rates are so high. AI going bust is plausibly the one thing that could send all that economic growth into sharp reverse. With spending commitments extending out several years at least, though, such a sharp reversal does not appear likely to materialize in the near- to mid-term.
On the other hand, growth is not just happening within the small coterie of enterprises directly involved in AI buildout. In the second quarter, seven of the nine major S&P 500 industry sectors registered double-digit or better earnings per share growth, with the overall EPS growth rate a stonking 52 percent. The third quarter looks to be strong as well, and economists now expect the growth rate for the full year to end up at around 32 percent. Those are not numbers that scream “recession imminent.”
So there are plenty of things to be concerned about in the current environment, and in particular there is likely a point, not too far away, when those interest rates will really start to flash red. But those who have spent the last four years awaiting that expected recession will probably be waiting for some considerable time to come.