Smoke, Mirrors and Fireworks

By Aoifinn Devitt, CFP® – Chief Investment Officer

As the July 4 holiday nears, there are fireworks by night and smoke by day, at least in our neighborhood in the Midwest. The grayish haze triggers a search for the “fire”, but of course that is hundreds of miles away and not visible. The fog and lack of visibility can be disorienting and disquieting, at a time when we should be experiencing some of summer’s longest, clearest days.

Reading markets these days has felt much the same. Much of the fog has been created by contradictory indicators: falling average home prices (the average home fell by 3.1% on the year – the single biggest annual drop since 2011) compared to a pick-up in housing starts. Both single-family and multi-family starts posted strong gains (up 18.5% and 28.1%, respectively1) in May.

There has been a softening in the manufacturing index (S&P Global’s manufacturing output PMI slid 4.2pts in June to 46.9, which marks a six-month low) even as stock markets remain resilient as we near the half-year point.

Source: Morningstar as of 06/28/2023

And what of the “fire” of a recession? In this case there does seem to be smoke without a fire, as actual, technical recessionary indicators are few and far between for now. This doesn’t take from the mood though, which seems gloomy in the media, although consumer sentiment has actually risen and in June the University of Michigan consumer sentiment indicator was at a four-month high (although still below pre-pandemic levels). Much of this is traced to fuel prices, which are falling, and indicators that inflation is no longer actually rising, even if it remains high.

Other contradictions include the inverted yield curve which indicates that bond markets are persisting in not taking the US Federal Reserve completely at its word – they expect rates to fall in the medium term. On the other hand, the message from Chairman Jerome Powell was “higher for longer” at this week’s meeting of central bankers in Sintra, Portugal would seem to reinforce the Fed’s stance to keep tightening.

The parallel nature of central bank actions – albeit uncoordinated – does offer up a “mirror” of sorts through which we might estimate the transmission effect of rate rises and see other potential collateral damage at home by looking at the situation abroad. One useful mirror could be the situation in the UK, where a sizeable 50 bps rate move last week by the Bank of England immediately triggered concerns of a crippling increase in mortgage payments to UK borrowers, where frequent re-financings and short-term discount fixed rates are the norm. The fear of the impact on stretched consumers of mortgage payments rising by up to four times led to more “temporary measures” by a group of mortgage lenders aimed to keep monthly payments in check. These measures included a moratorium on repossessions for 12 months as well as an ability to push out mortgage periods or switch some principal/interest arrangements to interest only for a  six-month period. It is intriguing how quickly these measures have come into effect and a reminder of the disproportionate effect of steeply rising rates, which don’t affect all consumers equally.

Other unintended yet anticipated consequences of the steepest rate rise cycle in recent history continue to be the impact on bank balance sheets and this time it was Bank of America that reported paper losses in its bond portfolio of over $100 bn, accounting for a fifth of the overall unrealized losses in the US’s 4600 banks at the end of the first quarter, according to FDIC data. While the bank can absorb this level of paper losses without further strain, the losses are a reminder that reaching for yield during times of lower interest rates could indeed have savage consequences.

Finally, the geo-political scene remains electric, and fireworks continue to emanate from Russia.  While the impact of the standoff between mercenaries and President Putin was limited when it came to markets, the fact that it took so many market commentators by surprise was a reminder of how little is really known about the dynamics in this region now that it is essentially cut off from former trade partners.

The summer seems set to continue to crackle – there is so much in the way of market kindling.  Happy 4th of July to all of our readers.



1  – United States Census Bureau; Monthly New Residential Construction, MAY 2023. June 20, 2023.



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