Investors were jolted by a stronger-than-expected retail sales report on Tuesday, which underscores the dual-edged sword now facing markets.
July’s 0.7% surge in retail sales is helping to bolster the view that a resilient U.S. economy can avoid a recession, despite more than a year of rate hikes by the Federal Reserve. However, the data also serves as another piece of information that some policy makers can use to support even more hikes in the final four months of this year, and left the benchmark 10-year Treasury yield
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trading at one of its highest levels since 2008.
Read: Fed’s Kashkari says inflation is ‘still too high’
Rising yields are generally seen as having a detrimental impact on U.S. stocks, though it’s not clear how high they’ll need to go to do that on a sustainable basis and much depends on how fast those rates rise. Higher yields can also sometimes be helpful to risky assets. Equities managed to rally through the first half of this year, even while the 10-year rate was in the process of rising from its 52-week low of 2.82% reached on Aug. 16, 2022.
The fear now is that a 10-year yield that inches further above 4% from here will keep pushing up the cost of capital for small businesses and consumers, and put stocks on a wobblier foundation. Quincy Krosby, chief global strategist for LPL Financial in Charlotte, N.C., said “this is a situation when good news really is bad news,” and “an already sensitive” Treasury market and the equity market have been “jolted” by Tuesday’s data.
“The questions everyone is asking are, ‘Can inflation continue on a trajectory down given an environment where the consumer is in good shape, and does monetary policy have to cause explicit harm to the economy?’ Part of the lively debate now is around what our economy will look like after we have concluded monetary policy tightening and start to move rates back to normal,” said Keith Buchanan, senior portfolio manager at GLOBALT Investments in Atlanta, which oversees about $2.5 billion in assets.
It was only a week ago that concerns about China’s deepening slowdown had investors unnerved because of the risk that the world’s second-largest economy might drag the U.S. down with it. Investors have moved on and “that news cycle was rather quick” because China’s challenges “have been well-known and documented,” Buchanan said via phone on Tuesday.
July’s 0.7% surge in retail sales was the biggest increase in six months and came in above the 0.4% forecast of economists polled by The Wall Street Journal. Helping to drive those sales was strength in Internet purchases on Amazon Prime Day.
Tuesday’s report was enough for economist Daniel Silver of JPMorgan Chase & Co.
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to say there is now “upside risk to our 2.5% real GDP growth forecast” for the third quarter. The Atlanta Fed now estimates that the U.S. economy is on track to grow at a frothy 5% annual pace in the current quarter. And rates strategist Ben Jeffery of BMO Capital Markets called the retail sales data “a strong look at spending in July, and another piece of information that will bolster soft landing conviction.”
All three major U.S. stock indexes
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opened lower on Tuesday after the retail sales report and then extended their declines, with Dow industrials finishing down by 361.24 points or 1%.
The Fed has delivered more than five full percentage points of rate hikes since March 2022, lifting its main interest-rate target to between 5.25%-5.5% from almost zero. The 10-year yield, used as the benchmark for everything on auto and home loans to student debt, briefly touched almost 4.27% before ending at 4.22% on Tuesday. Fed funds futures traders initially priced in a slightly bigger chance of a 25-basis-point rate hike in September, before backing away as Tuesday’s session wore on.
“The better-than-expected retail sales growth in July is another sign that the economy continues to grow at an impressive pace,” said Sam Millette, fixed-income strategist for Commonwealth Financial Network in Waltham, Mass. “Consumer spending has remained resilient throughout the year and helped fuel the solid economic growth that we saw in the first half. The continued strength of the consumer to start the second half of the year is a good sign for the health of the economy and a recession remains unlikely as long as consumers keep spending.”