While the market stumbled in August for most of the month, it is fair to ask if this is the start of something worse or merely a pause for the broader market. Occasionally, the answer to this question lies within the realm of the bond market, where we analyze credit spreads. To bring you up to speed, a credit spread denotes the divergence between the interest rates offered by a US Treasury bond and those offered by another debt security with an identical maturity. If we regard the US Treasury as a risk-free investment, then the question becomes, how much extra compensation must a corporation provide to entice investors to buy their debt instead of opting for the safety of the US government’s debt? This, in essence, defines the concept of a credit spread. A narrower spread implies that the market perceives the corporation’s debt as relatively low-risk (a positive sign for corporations), whereas a wider spread suggests significant risk associated with those corporations, for which investors demand higher compensation to assume that risk.
In the chart below, we illustrated the credit spread between US Corporate BBB debt and a Treasury Bond represented in purple, compared to the performance of the SP 500 index depicted in orange over the past 12 months.
The inverse relationship between these two inputs takes on particular importance during periods of market volatility. As shown in October 2022, credit spreads had ballooned to over 2%, but have since receded to 1.51% at the time of this report. While these rates undergo daily fluctuations, there has been no pronounced surge in credit spreads. This consistency provides investors with a valuable gauge for assessing market volatility and discerning whether heightened risks lie ahead.
Crude Oil Futures, Higher Oil Prices Ahead?
Oil prices have recently hit their highest monthly closing levels since October 2022. In the chart below, we can observe a shift in the dynamics of the former resistance level dating back to 2018, which now appears to be functioning as a more recent support level at around $70 per barrel.
While energy stocks demonstrated strong performance in 2022, 2023 has not witnessed a similar continuation of this momentum, primarily due to the declining prices of crude oil. From an investment standpoint, the prospect of higher crude oil prices sets up well for the energy sector. The chart below juxtaposes the XLE ETF with the price of crude oil, revealing a recent dislocation that suggests the possibility of an upward trajectory in crude oil prices.
Rise in Unemployment, Rate Hiking Almost Done?
In August, the job market saw an increase of 187,000 positions, yet the unemployment rate ticked up to 3.8%. This shift follows a streak of 29 consecutive months during which job creation consistently exceeded 200,000 jobs per month. The rise in unemployment is attributed to more individuals actively seeking employment, thus expanding the pool of job seekers in relation to the number of jobs added. This phenomenon coincides with other economic indicators displaying a degree of weakness, suggesting that the Federal Reserve’s rate hikes have been effective in curbing inflation but are also contributing to a softening in overall economic conditions.
Below are few other economic variables that we have kept our eye on.
- Existing Home Sales: -2.2% in August from July
- Credit Card Delinquency Rates: 7.51% in Q2 2023 vs 6.01% from Q2 2022
- Car Loan Delinquency Rates: 7.3% in Q2 2023 vs 6.9% from Q1 2023
The spotlight now turns back to the Federal Reserve who will have an official meeting in September giving them another opportunity to hike rates again or pause. While the recent softening of economic data may raise concerns on the surface, we believe it offers the Fed the chance to exercise caution while awaiting additional data. According to the CME FedWatch Tool, there is a 91% probability that the Fed stays put in September. We will see what ultimately happens, but our opinion is that a pause is a favorable outcome for investors and the economy.
Articles We’re Reading
Despite concerns about waning excess savings, US consumers have plenty of firepower left (Business Insider)
Recent GDP forecasts for 5.8% growth likely to be revised lower (link)
Fed, ECB push back against calls to deviate from 2% inflation target (Reuters)
OpenAI on Monday announced its biggest news since ChatGPT’s debut (CNBC)
For the Month Ending 8/31/2023 (Cumulative Returns)1
1Source – Morningstar, Inc. Corporate Bonds is presented as the iShares iBoxx $ Investment Grade Corporate Bond ETF. Municipal Bonds is presented as the iShares National Municipal Bond ETF. High Yield Bonds is presented as the iShares iBoxx $ High Yield Corporate Bond ETF. 10 Year Treasury refers to the valuation of a 10 Year Treasury Note, a debt obligation issued by the U.S. Department of the Treasury. Fed Funds Target represents upper limit of the federal funds target range established by the Federal Open Market Committee. Inflation Rate provided for the purposes of this report by the U.S. Bureau of Labor Statistics. Unemployment Rate calculated by the U.S. Bureau of Labor Statistics. WTI Crude Oil refers to the price of a barrel of West Texas Intermediate NYMEX) Crude Oil. Gold – Spot Price relates to the valuation of an ounce of gold, as traded on the NYSE Arca Exchange. U.S. Dollar refers to the U.S. Dollar Index (DXY). All Returns are denominated in USD (United States Dollar), unless otherwise explicitly noted.
Did You Know?
The first newspaper in the United States was published on September 25, 1690. It was called “Publick Occurrences Both Forreign and Domestick” and was printed by Benjamin Harris in Boston, Massachusetts. However, this newspaper faced immediate suppression by colonial authorities, and only one issue was ever published. It wasn’t until several years later that more successful and long-lasting newspapers like the “Boston News-Letter” (1704) and the “New-England Courant” (1721) were established in the American colonies.
Presented by the Investment Committee of Lake Street, an SEC Registered Investment Adviser
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