The push-pull dynamic of reopenings and increased spread of Covid-19 dominated last week with the U.S. seeing a record rise in the total number of new cases. Equities closed on their lows Friday, as some of the hardest-hit and most populous states in the South and West saw Covid cases surge, prompting a pause or rollback of their reopening processes.
Domestic equities led the way lower for the week (SPX -2.9%), while emerging markets outperformed (MXEF -0.1%) due to resilience in Asian markets. International developed market equities declined 1.3% (MXEA) [Figure 1]. As you’d expect in a week where virus fears dominated, the weaker portions of the domestic market, including value and smaller cap segments, underperformed the more resilient growth and larger cap names.
Despite losses, S&P 500 up 17% in 2nd Quarter
Last week likely also saw some rebalancing activity heading into month- and quarter-end. Despite last week’s losses, the S&P 500 is still up 17% in the 2nd quarter [Figure2]. We expect some chopiness over the next few days, especially because many (remote) trading desks are likely to be thinly staffed due to Friday’s July 4th holiday.
Reflecting on the quarter shows just how strong — and volatile — narratives have been in driving price action. Beginning with a “don’t fight the Fed” rally in early April, markets then chopped around as lockdowns were in full force. The initial reopening went well, exceeding expectations, which led to “stocks only go up” retail euphoria. And now the last two weeks have extinguished that narrative, putting investors back on a cautious footing heading into the 3rd quarter.
U.S.-China tensions flare again
The reaction last week to White House trade advisor Peter Navarro’s comments that the trade deal with China was “over” — and the swift denial that followed from the President — shows where the U.S.-China relationship stands: muddling through a sour situation. It seems that for now, at least, the White House views the risk of an equity selloff as greater than the reward from stoking anti-China tensions. But this could change as the election nears, considering anti-China sentiment is one of the few issues on which there is still some bipartisan agreement.
PMI readings reflect rebound in services
Last week’s euro zone PMI readings for the month of June showed a stronger-than-expected rebound in activity across the board. Because of economic and cultural similarities, Europe may be a better model (than China) for recovery here in the U.S. Seeing services in Europe rebound as strongly as they have could be a positive for us, given the importance of the sector to our own economy.
Bond yields fall and spreads widen
Government bond yields fell last week, driven lower by equity weakness and concerns about a backsliding in the reopening process. The curve flattened with the 2-year down 2 basis points (bps), the 10-year down 5 bps, and the 30-year down 9 bps. It’s worth highlighting just how boring a quarter it’s been in the government debt market. Despite a few days of excitement around a “breakout” higher in yields in early June, the 10-year spent the quarter in a range between .55% and .75%, closing Friday right in the middle at .64%.
It’s striking that in a quarter where the S&P 500 gained 17%, QTD changes in all major government benchmark yields are under 10 bps. The Fed has done an outstanding job at getting the U.S. Treasury (UST) market under control. In light of this, and because of recent Fed messaging, they’ll likely keep yield curve control as an unused policy in their toolbox for now.
Credit spreads widened out last week, with investment-grade (IG) and high-yield (HY) up 2 bps and 26 bps, respectively. But the Fed’s words, and limited actions, have really been effective the quarter overall. IG spreads have fallen 32 bps and HY spreads have declined 130 bps QTD.
Fed balance sheet shrinks for 2nd straight week
The Fed’s balance sheet shrunk again for the second straight week, and concern is mounting that it may be stepping away from supporting markets and growth. This could not be further from the truth. Rather, it is another testimony to how effective the Fed has been in restoring market function.
This specific decline is due to the rolling off of U.S. dollar (USD) funding transactions with foreign central banks, initiated in the depths of March. Now that markets have calmed down, this excess liquidity is no longer needed to keep the USD from appreciating. Indeed, the broad USD is down 2% in the 2nd quarter.
What to watch next
Impact of Surge in Covid Cases
In the upcoming shortened week due to the July 4th holiday, Covid headlines are likely to be the main driver of markets again. The biggest concern is the extent to which a rise in Covid infections could stymie reopening momentum. And what are the implications for growth longer-term? Will we snap back to pre-Covid levels or settle in somewhere lower than before?
Consumer confidence is out on Tuesday and is likely to continue to improve from May’s reading. Despite record-high unemployment and depressed levels of economic activity, future expectations remain remarkably elevated. In other words, the consumer has not given up to despair yet. But if consumer spending is the engine that drives economic growth, then paychecks are the fuel. With extended unemployment benefits due to expire in July, the market will be closely watching Phase 4 package negotiations taking place in Congress, as well as the monthly jobs report due out on Thursday this week.
U.S. Monthly Jobs Report
The monthly jobs report from the Bureau of Labor Statistics (BLS) comes out Thursday instead of Friday due to the shortened holiday week. It’s expected to show an increase of 3 million jobs for June and a drop in the unemployment rate. However, after last month’s epic miss, confidence in expectations isn’t as high as it could be. BLS has admittedly faced challenges in measuring the actual rate of unemployment, indicating the survey it uses wasn’t designed to measure the unprecedented pace and scale of changes taking place in the labor market now. It’s likely that actual unemployment numbers for April and May were higher-than-reported.
While it will be important to see employment continue to trend in a positive direction, the June report won’t reflect the potential impact of Covid surges and the resulting delays or rollback in reopenings that we’re seeing now.
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