Market action this past week has been primarily driven by the reaction to the Federal Reserve’s (Fed) more hawkish statement last Wednesday and the softer economic data released. Equities traded sideways last week after putting in a strong performance during the first three weeks of October. The Fed’s more hawkish tone has caused interest rates to increase and prices to decline for fixed income securities. The underperformance of fixed income has been exacerbated by spreads widening due to merger and acquisition (M&A) activity.
U.S. Treasury bonds experienced a significant bear flattener (short maturity interest rates up more than longer maturity) after the Fed’s announcement, and on Thursday the market experienced a sizeable bear steepening (longer maturity rates up more than shorter maturity). I was talking with one of our portfolio managers about possible reasons for the reversal, and we could not come up with a clear reason for the change in market tone from day-to-day. The conversation reminded me of a terrific response that I heard once when a long-term investor was asked what caused the market to decline that particular day. Without any hesitation he responded, “More sellers than buyers.” The financial media has created many sources to describe and analyze day-to-day market action, but in the end it is supply and demand and the fundamentals that cause prices to change.
Last week’s economic data confirmed that inflation is still low and that U.S. growth is moderate. The core PCE deflator (personal consumption expenditures) has fallen back to a year-over-year increase of 1.3% and the Economic Cycle Research Institute wage growth has declined to 2.0%. I do expect this week’s October employment number to be impactful to the debate about any potential Fed tightening in December. Also watch for continued strength in the U.S. dollar as an indicator of pressure in the financial system. I would expect to see the dollar strengthen versus other currencies over the next few months.
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