The market broke out to another high, continuing the stair-step pattern of consolidation, then another step higher. Fed Chair Janet Yellen testified before Congress and emphasized that rate hikes would be very deliberate and moderate. The market took that as good news and shot equities higher.
Bonds moved up by 0.43% as interest rates dropped on the testimony. The 10-year fell to 2.33% from 2.39%. Crude rallied by 5%.
Investors now view the probability of another interest rate hike this year as less likely. Yellen’s testimony, coupled with less than sanguine economic reports, makes it more likely that a September hike is off the table and lowers the probability of a December increase.
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US equity markets were basically even, +0.06% while international markets fell by almost 1/2%. Bonds declined as interest rates continued to rise and the yield curve steepened. The dollar was up and crude was down.
It was one year ago, on July 6, 2016, that the 10-year treasury bond hit its all time-low yield of 1.367%. One year later, we are one point higher at 2.37%. The 10-year has traded in a range between 2.1% and 2.6% since the election and we are back in the middle of that range now.
Over the last couple of weeks, consensus has tilted back towards higher rates going forward. Minutes released from the June Federal Reserve meeting showed that members want to begin reducing the balance sheet before year-end. And European Central Bank minutes indicate that there were discussions of ending their pledge to buy bonds if the economy weakened. Depending upon the rate of increase, higher interest rates at some point would likely put pressure on equities. The interplay between higher earnings and interest rate will have a lot to do to determine the direction of the equity markets.
The June employment report came in strong. Non-farm payrolls increased by 222,000 and the two prior months were revised higher by 47,000. The unemployment rate increased to 4.4% from 4.3% due to more entries into the workforce, which is considered a positive sign. The average workweek rose by 0.1 hours to 34.50 and average hourly earnings were 2.50% higher year over year.
US equity markets were down by about 1/2% while international markets managed a 0.19% advance. The dollar fell and crude rallied by 7%.
Interest rates rose. The yield curve got steeper. The 10-year rose by 16 basis points. Central bankers are beginning to align themselves on the path to higher rates. The Fed has been increasing rates and have signaled more is on the way, as well as laying out the plan to reduce their bond holdings. But now some central bankers overseas might be joining the party. Mario Draghi of the ECB suggested that the bank might be close to ending its bond buying. And Mark Carney of the Bank of England suggested that a rate hike might be on the way.
As the quarter ended, analysts are forecasting Q2 earnings of $31.50, down from $32.13, according to FactSet. The 2% decline is lower than the drop-in forecasts in prior quarters, which have averaged 5.9% over the last 10 years.
Q1 GDP was revised up to 1.4% from 1.2%. The original estimate for Q1 real growth was 0.7%, and that was later revised up to 1.2%. GDP growth has picked up in Q2, the Atlanta Fed’s GDPNow model currently has Q2 growth at 2.7%. The first official estimate from the Commerce Department will be released on July 28.
The current economic expansion began in July of 2009 and is currently the third longest on record, surpassed only by expansions in the 1960s and the 1990s. However, the growth rate during this expansion has been sub-par, probably due to lower productivity and a decline in the labor force.