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Charts for the Week

September 18, 2023

Monetary Policy | Long and variable lags

Despite inflation popping higher in August, the consensus outlook remains for the Fed to keep interest rates steady until starting to lower them next summer. However, that outlook has changed frequently and is still far from certain. Complicating the picture for policymakers and prognosticators is the fact that moving away from an era of zero interest rates is bizarrely having a J curve effect on some parts of the economy, where higher rates are actually stimulative to a degree before they start to bite. 

One example of this J curve effect is corporate profits. Like the economy, profits have in general held up better than expected when the Fed started raising interest rates, and that is thanks in part to those higher rates that were supposed to derail everything. So far, the corporate sector has in aggregate been a net beneficiary of higher rates as far as earning more from higher yields on its cash holdings than it is paying out in higher financing costs on its debt. For nonfinancial companies, net interest expense has declined 31% since the first quarter of 2022. 

The corporate sector built up a significant amount of cash in recent years, and that stockpile is now earning a nice return over 5%. At the same time, like many homeowners (but not so much like the federal government), many corporations locked in low rates on a lot of their debt and thus have yet to feel the pinch of higher rates. 

Nevertheless, if the Fed stays the course long enough, higher rates will eventually have their intended effect of slowing the economy and dragging inflation back to 2%. Determining how high rates need to go and how long they need to stay there is complicated by the even longer and more variable lags of monetary policy that are the result of the extreme measures taken during the pandemic.  

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Sources:  Ycharts,, BEA, AOWM calculations

Corporate Profits | Another positive quarter

September 11, 2023

Corporate profits in the second quarter continued to surprise pleasantly to the high side for most companies. The generally positive earnings jive with the GDP data which seem to indicate the economy is chugging along at a solid pace despite numerous leading indicators flashing red. 

While earnings have come in better than expected in recent quarters, most of the rally in the market has been a function of investors bidding up the valuation for stocks as forward earning expectations have not changed much since last October. 

However, if current expectations hold, that will begin to change in the coming months with the consensus outlook calling for earnings to return to double digit growth over the next year. It will likely take more than a soft landing for earnings to gallop ahead at that rate, but investors have been rewarded in recent years for assuming the best. 

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The Economy | Approaching a critical juncture

September 4, 2023

Investors took a bad-news-is-good-news approach to much of the economic data released last week with the hope that weaker economic data means the economy is coming in for a soft landing and the Fed will not have to raise interest rates any higher.

While 187,000 new jobs were estimated to have been created last month, the data for previous months continues to be revised lower and the pace of job growth has continued to slow. The growth in Gross Domestic Product for the second quarter was also revised lower, and its twin measure, Gross Domestic Income, continued to paint an incongruent picture of a much weaker economy. 

If the economy is to avoid a recession, the next few months will be a critical test. And, given the data revisions and statistical discrepancies inevitable in trying to measure a $27 trillion economy, we will likely not confidently know the answer for some time thereafter.   

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The Fed | Navigating by the stars under cloudy skies 

August 28, 2023

The Chair of the Federal Reserve, Jerome Powell, reiterated last week the Fed’s commitment to bringing inflation back to 2% and the likely need to keep interest rates higher for longer to achieve that goal. He also highlighted the uncertainty plaguing policymakers and ended his speech at the Jackson Hole Economic Symposium by noting that the Fed was "navigating by the stars under cloudy skies." 

The labor market is one example of the cloudy outlook confronting the Fed and investors. On the one hand, the unemployment rate remains low, unaffected so far by the increase in interest rates over the past eighteen months. On the other hand, the estimates of new jobs created are being consistently revised lower,  job openings are declining, and continued claims for unemployment insurance are increasing. The labor market is the ultimate lagging indicator of the economy's strength, and thus signs that it is weakening are also at odds with other data suggesting the economy is reaccelerating towards faster growth. 

Given the lack of clarity and policymakers’ repeatedly stated commitment to reducing inflation, the Fed seems inclined to risk keeping interest rates a little too high for a little too long. 

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The Consumer | Facing new hurdles  

August 21, 2023

While most investors aren’t thrilled with the idea that interest rates may stay higher for longer, fears of a recession are receding as the economy continues to grow, inflation has come well off its high, and unemployment remains low. The picture remains far from clear, however, and it is still too early to gauge the ultimate effect of the Fed’s tightening monetary policy.


In addition to higher interest rates, the fabled American consumer - whose spending accounts for over two-thirds of the economy - also faces new hurdles in the coming months that may yet trip the economy into a recession. First, over $1 trillion of federal student loans will no longer be in pandemic forbearance starting in September, leaving nearly 27 million individuals with a monthly bill they haven’t had to worry about for the past three years. Second, the excess savings that individuals built up during the pandemic is almost gone. If the savings rate returns to levels seen before the pandemic, that could be a further headwind for personal consumption. 

Economic activity doesn’t grind to a halt in a downturn. Recessions happen at the margin, and the current economy faces an elevated risk that the marginal purchase or investment may not be made in the coming quarters.  

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Inflation | Historic run comes to an end  

August 14, 2023

Annual inflation, as measured by the Consumer Price Index, ticked higher in July to 3.2% after declining for a record twelve straight months. Underlying inflation trends remained generally positive, but year-over-year headline inflation is still likely to remain sticky in the 3% to 4% range for the remainder of the year thanks in large part to the estimate for shelter inflation which is expected to moderate slowly. 

While an uptick in annual inflation was anticipated, the stock and bond markets still sold off slightly last week as expectations for another potential Fed rate hike in November increased and the projected start date for rate cuts was pushed back to May. Inflation was never going to retreat to 2% in a straight line; however, the inevitable hiccup raises the specter of another inflation wave à la the 1970s. 

The ghost of the 70s is what will likely keep the Fed pushing interest rates higher for longer and in turn keep the risk of a recession elevated. 

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Sources:  Ycharts,, BLS, AOWM calculations

Yield Curve | Long end rising  

August 7, 2023

Last week, investors were reminded of the federal government’s poor fiscal health when one of the credit rating agencies downgraded US Treasury debt to one notch below the highest AAA rating. While the downgrade is unlikely to have any direct practical implications, it still helped to push the yields on long-term Treasurys higher. 

Over the past several months, long-term interest rates have risen primarily on growing economic optimism. The 10-year Treasury yield is now back above 4% and near the level it reached both last fall and this spring before the bank failures. The yield curve remains deeply inverted with short-term rates well above long-term rates, but it is flatter than it was a couple of months ago. Typically the yield curve regains its normal shape from an inversion as the Fed lowers short-term rates to bolster a slowing economy.

Whether anticipating a recession or not, investors generally agree the yield curve will again right itself as the result of Fed rate cuts starting next spring. If long-term rates stay roughly where they are now, the yield curve could be returned to its normal upward-sloping shape by the end of 2024 based on investors’ current outlook for monetary policy. 

A scenario that would catch many investors by surprise is if long-term rates rise to meet current short-term rates. While it would be a deviation from the experience of recent decades, it is not a far-fetched possibility if inflation remains sticky, the Fed remains resolute, the economy remains above water, and the Federal government remains profligate. Wilder things have happened in recent years. 

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Sources:  Ycharts,, US Treasury, AOWM calculations

Residential Investment | Buoyed by golden handcuffs  

July 31, 2023

The preliminary estimate by the Bureau of Economic Analysis indicates that the US economy continued to chug along in the second quarter with real growth bouncing around 2% year-over-year. Residential investment has not been a source of growth over the past year, but it has bolstered the economy by not being as big a drag as feared.

When mortgage rates spiked to 7%, residential investment did slow as expected; however, it didn’t crater as the Fed has unintendedly created a squeeze in the housing market. One side effect of the Fed pushing interest rates to ultra-low levels during the pandemic was that it locked many homeowners into mortgages with very low rates, making them far less inclined to move. At the end of last year, 62% of outstanding home mortgages had a rate below 4%. As a result, the number of existing homes on the market is at an extremely low level, which has so far kept new home construction from falling as much as it has in previous downcycles. 

Whether the current uptick for homebuilders is a momentary pause before a recession hits or what will happen when mortgage rates come back down (assuming they do) is anyone’s guess. The wild pandemic stimulus will likely continue to have unexpected consequences for years to come.  

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Expectations | Change slowly  

July 24, 2023

Investors continue to push the stock market closer and closer to new all-time highs even as valuations creep higher and the short-term economic outlook at best seems to be indicating slow growth. 

Investors also appear to be disregarding the high probability that falling interest rates and declining corporate tax rates will no longer bolster long-run profit growth as has been the case for the past several decades. An economist at the Federal Reserve recently estimated that “lower interest expenses and corporate tax rates mechanically explain over 40 percent of the real growth in corporate profits from 1989 to 2019.” 

People are prone to project the recent past into the future. And declining interest rates, expanding profit margins and fast earnings growth has been the recent experience. Even if interest rates retreat to their pandemic lows, tax rates don’t change and profit margins remain high, future long-run earnings growth is likely to be significantly slower than it has been in recent decades. Nevertheless, given our human bias to overweight the recent past, it may take a few bear markets for investors’ expectations to change – or AI may just change everything.  

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Inflation | Mission Accomplished?  

July 17, 2023

Annual inflation fell for the twelfth consecutive month in June, declining from 9.1% to 3.0% over the past year as measured by the year-over-year change in the Consumer Price Index (not seasonally adjusted).  The unusually rapid, consistent disinflation has buoyed investor sentiment and hopes that the Fed will not have to push the economy into a recession to bring inflation back to its 2% target. 

Despite the good news, policymakers are wary of declaring “Mission Accomplished” too soon. Indeed, quite the opposite, as the Fed is poised to resume raising short-term interest rates again this month. Core inflation excluding food and energy prices has not declined as swiftly as policymakers would like, and headline inflation is unlikely to continue declining in the coming months. 

Seasonally most of the increase in the aggregate price index occurs in the first half of the year, while there is typically minimal measured inflation in the latter half. For the first six months of 2023, the Consumer Price Index (not seasonally adjusted) is already up 2.8% (5.7% annualized), so any incremental price increases in the coming months will push inflation up from its current level of 3% and potentially keep the Fed raising rates higher for longer than investors expect. 

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Sources:  Ycharts,, BLS, AOWM calculations

Bond Market | Mixed messages 

July 17, 2023

The bond market is often cast as the dour sidekick to the sunny stock market. To be sure, the source of many recession fears is the deeply inverted yield curve which is a classic indicator of a pending downturn. However, bond investors are optimistic on a couple of fronts, which don't fully jive with a recession prediction.

Over the past two months, interest rates across the yield curve have moved higher as strong economic data and fading concerns about bank failures have led investors to believe that the Fed will indeed keep short-term rates higher for longer. At the same time, bond investors remain sanguine about the outlook for inflation and the credit quality of corporate debt – a combo that would imply a successful soft landing for the economy and not a recession. 

While real, inflation-adjusted rates have increased significantly as a result of the Fed's response to surging inflation, investors' expectations for inflation in the market for Treasury Inflation Protected Securities (TIPS) have remained well anchored near the Fed’s 2% target. At present, investors appear confident that the Fed will get inflation back under control relatively quickly and not adjust its target higher in response to intransigent inflation. 

There also seems to be little concern about the effect of those higher real interest rates in the corporate bond market where investors are not demanding much additional return to invest in corporate debt versus US Treasury debt. If recession fears were running rampant, credit spreads would likely be widening, not trending lower. 

Maybe this time is different for the yield curve as a predictor of a recession – or maybe bond investors are just as torn between hopes and fears as everybody else. 

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Sources:  Ycharts

Corporate Profits | Pause or pivot? 

July 3, 2023

Much of the market narrative in the first half of the year centered around whether and when the Fed would pause rate hikes or even pivot to cutting interest rates -- and how investors would meet that moment with exuberance. And yet investors now seem unbothered by the prospect of interest rates likely heading higher for longer. Turns out the pause-or-pivot question more important to the market so far this year may have centered around profits, not monetary policy.

At the end of the day, fundamentals drive stock returns. In 2022, it appeared that corporate profitability had begun a potentially long hangover from the pandemic high. However, first-quarter profits broke the downtrend and fed a growing bullish sentiment. The pause in the expected earnings recession has investors hoping it will turn into a full pivot towards renewed strong earnings growth that will keep stocks moving higher. 

The Fed’s actions will still play a role in where the economy and profits go from here, so investors may return their attention to that pause-or-pivot question before long.   

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Leading Indicators | Still mostly negative 

June 26, 2023

Except for the stock market, most leading indicators continue to signal a recession is likely on the horizon. The Conference Board’s Leading Economic Index® has now declined for fourteen straight months and has been flashing a pending recession warning for several months. And yet with each passing month that the labor market remains strong and inflation inches lower, the hopes that this time will be different grow. 

One area of the economy that seems to be rebounding quickly from a brief slowdown is residential investment as building permits and housing starts have ticked higher this year. Higher mortgage rates have decreased the affordability of houses, but they have also constrained the supply of existing homes for sale which has buoyed the market for new homes. 

The experience in the housing market has raised the notion that we will have a rolling recession that hits sectors at different times but is sufficiently spread out that the overall economy never experiences a widespread retrenchment in employment or output. The Composite of Leading Indicators published by the Organization of Economic Cooperation and Development (OECD) offers this theory some support as it continues to point to sub-par growth over the next year, but not yet a recession. 

The one leading indicator that continues to toll the bell loudly for a pending recession is the yield curve which is deeply inverted with the 10-year Treasury 1.67 percentage points below the 3-month Treasury as of Friday. The bond market seems to be completely at odds with the stock market, which isn't particularly unusual. Over the past few decades, however, the bond market has been the wiser of the two in foreseeing trouble as the stock market would trade near all-time highs while an inverted yield curve rightly urged caution.  

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The Fed | Just catching its breath 

June 19, 2023

At their meeting in May, policymakers at the Federal Reserve raised interest rates for the tenth straight time but suggested the May rate hike might be their last for this tightening cycle. At their meeting last week, they did not raise rates but indicated further hikes are now likely before the end of the year. 

The Fed’s preferred inflation metrics have improved but at a slower pace than policymakers had expected which led to the forecast for further increases in their target fed funds rate - the overnight interest rate for interbank lending. One way or another, either through rising rates or falling inflation, policymakers anticipate financial conditions will continue to tighten over the next eighteen months as the real fed funds rate adjusted for inflation rises towards 2%. 

The economy and the markets have so far held up well in the face of the Fed’s blitz of rate increases from basically 0% to over 5%; however, that may be partly because monetary policy has remained relatively accommodative over the past year as the Fed has been working to drain an unprecedented amount of stimulus from the system. Even now monetary policy can only be seen as restrictive when viewed through the lens of the past fourteen years of negative real interest rates and ever-expanding asset purchases by the central bank.  

The true test will come over the next year as monetary policy continues to tighten to levels not seen since before the Great Recession and its lagged effects on the economy are fully felt.  

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June 12, 2023

GDI | Already a hard landing? 

With the S&P 500 up 20% from its October low and the financial press cheering a new bull market, investors seem to be increasingly pricing in the expectation that the economy will avoid a recession and profits will quickly rebound higher. Meanwhile the economic data remains mixed but still seems consistent with the forecast for the economy to slip into reverse around the end of the year. One measure that is incongruent with the market’s outlook is the government’s estimate of inflation-adjusted Gross Domestic Income (GDI), which has declined the past two quarters and is currently below the level reached at the end of 2021.

In theory, GDI should equal the Gross Domestic Product (GDP) as an equivalent but different measure of the size of the economy. GDI is estimated by collecting income data, and GDP by collecting expenditure data. There is always some statistical difference between the two, but the twin measures have not painted such a different picture of the economy since 2007 when GDI indicated the economy was sliding into a recession while GDP showed it was still growing. 

Given the imperfections of both estimates and the inevitable future revisions to those estimates, some insight about the true state of the economy may be gleamed by taking the average of the two. Doing so suggests the economy has basically been trending sideways since the end of 2021. The economy may yet turn up without a recession as investors are expecting. Weighing against that bet are several factors including inflation that has yet to be completely subdued, higher interest rates, tightening credit, and the end of the last vestiges of pandemic stimulus, all of which may continue to decrease the aggregate demand for goods and services as the year wears on. 

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Sources: YCharts,, AOWM calculations

Labor Market | Strong but slowing 

June 5, 2023

The labor market remained strong in May with employers initially estimated to have added 339,000 jobs and the unemployment rate remaining low at 3.7%. Even though there were indications of further softening in the data, the jobs report increased the odds that the Fed will raise rates again later this summer.

Employment is a lagging indicator of the economy’s strength as employers generally avoid letting workers go as long as possible. That may be even more true in the current environment after workers were so hard to find coming out of the pandemic. The decline in average hours worked and weak productivity data suggests employers may indeed be holding on to workers even as demand begins to weaken.  

The unemployment rate also increased 0.3 percentage points in May as the household survey continues to show weaker employment growth than the payroll survey. In addition, while estimates of payroll gains in March and April were revised higher, initial payroll estimates have been ultimately revised lower more often than not over the past year which may be another indicator that we are in the midst of a turning point for the labor market.

The current strength in the employment data is not overly surprising based on previous Fed tightening cycles. If it remains strong in the face of the headwinds confronting the economy in the latter half of the year, that will be unexpected and perhaps a complication for the Fed's efforts to tame inflation. 

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AI | Blowing bubbles?

May 29, 2023

Since the artificial intelligence (AI) chatbot ChatGPT was released last November, interest in AI has exploded, offering growth technology stocks another shot of adrenaline. The AI story is largely holding up the broader market indexes so far this year with some valuations starting to look rather bubblish again after briefly retreating from such levels in 2022. But can the run in AI stocks continue in the current economic environment?

Speculative bubbles typically thrive on two things: a narrative about a glorious future that goes viral and easy credit. AI has the first part in spades as the technology has the potential to be truly revolutionary and has clearly caught the public's imagination. However, the AI bubble will have to overcome a tightening credit cycle if it is to continue to inflate. That said, there may still be enough juice left in the system from all the pandemic stimulus to let the AI stocks run for a while. 

From a long-term perspective, bubbles generally look ridiculously irrational, but in the moment it can be perfectly rational to buy a stock that the herd seems determined to push higher. The challenge is getting out of the herd’s way when it changes direction. 

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Sources: YCharts,, AOWM calculations

Debt Ceiling | Fiscal fig leaf

May 22, 2023

The cash reserves of the federal government are running low as the powers-that-be continue to negotiate an increase to the statutory debt limit. It is generally viewed as unimaginable that the historically meaningless debt ceiling won’t be raised as it has been 78 times since 1960. Accordingly, financial markets have largely shrugged off the drama. Nevertheless, the nation’s growing fiscal imbalances will ultimately require more than a fig leaf of attention, potentially sooner rather than later since the pandemic increased the federal debt held by the public to around 100% of GDP. 

Even with the pandemic in the rearview mirror, the government is still running a nearly $2 trillion deficit which equates to more than 7% of GDP. That is half of what the deficit was at its pandemic peak, but it remains historically elevated especially considering that the unemployment rate is at its lowest level in 70 years. If there is a recession in the next year, the deficit will naturally widen even more and further exacerbate the long-run fiscal challenges facing the country. 

Some combination of lower discretionary spending by Congress, higher taxes and higher inflation seems a likely result of the growing gap between federal receipts and outlays -- barring a technological miracle that dramatically lowers health care costs or accelerates economic growth, which the political class may hold out hope for as long as possible until events force them to do otherwise. 

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Small Caps | Not feeling very bullish

May 15, 2023

The stock market continues to trend sideways, held up primarily by the stocks with the largest market valuations. While seemingly going nowhere fast, the S&P 500 Index still remains more than 15% above the low reached last October. Small cap stocks, on the other hand, have traded back toward the lows with the Russell 2000 Index down nearly 29% from its all-time high.

Small cap stocks typically lead the market coming out of a downturn (or at least keep pace). They are clearly not doing that now. Thus if last October was the low, the market is defying its historical pattern, which it has frequently done over the past three years.  

On the positive side for small cap stocks is their relative valuation. The Russell 2000 is trading at less than 13 times expected earnings while the S&P 500 is over 19. Even if estimates for future earnings remain too optimistic and have further to fall, investors seem to have built some margin of safety into small cap valuations. 

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Peak Fed Funds | Wait and see

May 8, 2023

Policymakers at the Federal Reserve increased their target overnight interest rate to over 5% last week and indicated they will take a wait-and-see approach from here to evaluate whether they have done enough to bring inflation under control. The fed funds rate is now above most measures of inflation for the first time since 2019; however, in real, inflation-adjusted terms, the Fed’s target rate remains historically low unless inflation continues to fall relatively swiftly in the coming months. 

The Fed is looking for financial conditions to tighten further naturally from here with policymakers expecting the fed funds rate to be about 1.5% above falling core PCE inflation by the end of the year (which would still be well below where the real fed funds rate peaked in 2000 or 2007).  If inflation does not fall as forecasted, nominal rates will likely not have peaked after all. 

The strong labor market may complicate the Fed's contemplative pause. The unemployment rate fell back to the multi-decade low of 3.4% in April and has been below 4% for more than a year which has added to inflationary pressures. Unemployment often does not start to increase until several months after the Fed has stopped raising rates. But for policymakers hoping to be done with rate increases, it would be helpful for the imbalances in the labor market to start moderating sooner rather than later (ideally via a glorious soft landing of more folks joining the workforce than a big decline in employment). 

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Sources:  YCharts,, AOWM calculations

May 1, 2023

The Consumer | Still spending

Economic growth in the first quarter was weaker than forecasters had expected with the economy growing just 1.1% during the quarter at a seasonally adjusted annual rate. Quarter-over-quarter growth has been choppy over the past eighteen months, but the economy does seem to be trending towards slower growth, if not a recession.

To the extent the economy is growing, the consumer is primarily to thank. Businesses drew down inventories in the first quarter, which weighed on growth, but the consumption of goods and services continued to head higher. The economy has leaned heavily on personal consumption over the past few years as it has grown to represent nearly 71% of real GDP. 

The enormous stimulus doled out during the pandemic has fueled consumer spending. Consumers are likely still sitting on over $1 trillion more in savings than they otherwise would have had. That stockpile is being slowly whittled down but should continue to support the economy for the remainder of the year. Once it is gone, the economy will be more vulnerable to the Fed’s tightening monetary policy which is expected to go another rung higher this week. 

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The Markets | Unsettled quiet

April 24, 2023

The stock market has had a quiet start to the earnings season during which companies report their first quarter profits. Over the past two weeks, the realized and expected future volatility of the S&P 500 Index has fallen back to where it was at the market peak in January 2022. The seas have calmed quickly after the recent rattling storm of two large bank failures. 

It is unusual for the market’s daily swings to be this subdued during a bear market -- or the early stages of a new bull market if that is where we are. But the stock market has been anything but normal over the past three years. 

Adding to the eerie stillness of the stock market is the strange activity in the Treasury market where the yield on the one-month Treasury bill has cratered to 3.36% over the past few weeks even while expectations have increased for the Fed to raise its target overnight rate above 5% next week. It is unclear why the most liquid market in the world is behaving so oddly, though it may have something to do with concerns about the looming debt ceiling battle in Congress. 


Even without the potential for a brewing debacle in the nation's capital, the next two weeks are likely to make all financial markets livelier as two-thirds of the companies in the S&P 500 Index are scheduled to report their first quarter earnings and the Fed will announce its next interest rate decision. If the stock market sleeps through all that without at least a few characteristically erratic swings, something peculiar is afoot.

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April 17, 2023

After Rate Hikes End | Flip a coin?

Inflation continued to improve in March with the headline number falling to 5%. The Fed may still hike rates one more time next month as core inflation excluding food and energy is showing less progress, but the end of Fed rate increases seems imminent. 

What happens after the Fed stops raising rates? History tells us the stock market may go up – or it may go down. At the end of the past ten Fed tightening cycles, the market reacted positively six times over the subsequent six months. Half the time, however, significant market declines were still to come, including the false dawn in 2006 when the market sailed to new all-time highs in 2007 before the financial crisis struck. 

When policymakers finally do indicate that they think they’ve done enough, the decreased uncertainty around how high the Fed will raise rates may very well generate a momentary rally in the stock market. How long such a rally lasts will likely depend on corporate profits and investors’ risk appetites remaining robust. Stubborn inflation and/or a deep recession would dent both. 

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Sources:  YCharts,, AOWM calculations

Jobs Report | Bad good news?

April 10, 2023

The labor market remained strong in March with an estimated 236,000 jobs added and the unemployment rate ticking lower to 3.5%. The good jobs report has increased the odds that the Fed will raise rates at least one more time; however, the news was not all bad for policymakers striving to bring down inflation. 

The size of the labor force continued to grow at a healthy pace for the fourth month in a row as the labor force participation rate increased to its highest level since March 2020. The possibility of a soft landing always depended in part on drawing back into the workforce the individuals who left during the pandemic. 

Policymakers could also look past the good headline numbers and see signs of weakening in the labor market if they wanted a reason to pause their rate hikes. Private payrolls increased by the lowest level since 2020, and the number of temporary workers continued to decline compared to last year. 

Fixed income investors certainly seem to think the labor market is about to weaken substantially as the negative spread between the 10-year Treasury yield and 3-month Treasury yield reached a historic level of inversion last week. 

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Fed Remittances | No longer supporting Uncle Sam

April 3, 2023

During the era of Quantitative Easing, the Federal Reserve greatly expanded its balance sheet and made a lot of money. Last week the Fed released its audited financial statements for 2022 and reported net income of $60.7 billion. Over the past decade, the Fed’s annual earnings have averaged over $80 billion. This has been a wonderful free lunch for the federal government as the benefactor of the Fed’s earnings, but that free lunch has come to an end. 

The Fed started losing money in September as it began to pay out more in interest than it was earning on its portfolio of fixed income securities. It is now losing about $2 billion each week and has accumulated losses of $44.2 billion over the past seven months. Unlike some of the banks which have also been squeezed by low yields on long-term assets and rising rates on short-term liabilities, the Fed doesn’t have to worry about its solvency. It can effectively print money to meet its commitments and nicely gets to book its losses as a deferred asset because the losses reduce what it must remit to the Treasury in the future.

That through-the-looking-glass accounting unfortunately does not eliminate the reality that the federal government is losing what amounted to nearly $1 trillion in revenue over the past twelve years. Whether it was ever wise for the Fed to create that income stream will be long debated, but its loss will clearly add to the burgeoning federal debt which seems headed towards a day of reckoning that will force the powers-that-be to raise taxes and/or lower spending. 

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Interest Rates | Future path increasingly uncertain

March 27, 2023

Fed policymakers once again raised the fed funds rate by 0.25% last week while once again increasing their projections for inflation and lowering their outlook for economic growth; however, for the first time since they started tightening monetary policy, they did not raise their forecast for the peak fed funds rate. 

Policymakers still expect to raise the fed funds rate one more time by 0.25% to over 5% and then keep it at that level through at least the end of the year. Fixed income investors, on the other hand, think rates have peaked and that the Fed will be cutting interest rates by July. 

Everyone anticipates the recent turmoil in the banking industry will tighten the availability of credit and slow the economy. The disconnect between policymakers and investors is that market participants think more things are likely to break causing the Fed to reverse course to maintain financial stability. 

If fixed income investors are right, the economy will soon be in a recession, which has not been priced into the equity markets. If the Fed is right, interest rates will be higher for longer than either the fixed income or equity markets are currently expecting. In either case, markets will remain volatile given the heightened level of uncertainty.  

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The Fed | Stuck between a rock and a hard place 

March 20, 2023

Policymakers at the Federal Reserve meet this week to decide their next step in their battle against inflation, which is declining but remains well above the Fed’s 2% inflation target. The Fed’s next step was highly anticipated to be another rate increase of 0.25% or 0.50%, but the recent turmoil in the banking industry has complicated things. 

Based on the market for fed fund futures, investors still view it as more probable than not that the Fed will raise its target fed funds rate to between 4.75% and 5%. Last week the European Central Bank raised its target interest rate by 0.50% despite the banking issues rattling the Old World. Given regulators’ reassurances about the soundness of the US banking industry and the persistence of high inflation, it will be hard for policymakers to pause their rate hikes now. 

If the Fed does raise rates this week, we will enter a strange world in which the Fed is increasing interest rates while simultaneously loaning hundreds of billions of dollars directly to banks to calm nervous depositors concerned about rising interest rates. But we live in strange times, and policymakers may be stuck with no better options. 

Sources:  YCharts

Bank Failures | Changing investors' outlook for rates 

March 13, 2023

The past week has been eventful. The Fed Chair, Jay Powell, first led investors to believe that the central bank would push interest rates higher for longer to combat inflation. Then the 16th and 29th largest banks in the US quickly failed leading investors to wonder if the Fed is about to pivot in dramatic fashion towards lowering rates and once again injecting large sums of money into the system.

The two banks that failed, Silicon Valley Bank and Signature Bank, rode the large wave of monetary stimulus during the pandemic with their market capitalizations surging to over $43 billion and $22 billion, respectively, just 14 short months ago. However, they both fell victim to an old fashion bank run over the past week. 

Banking by its very nature depends on the confidence of depositors – only about half of all bank deposits are insured by the FDIC, and banks on average only keep about 10% of the deposits they hold in cash. Thus if there is a loss of faith in an institution, it can quickly get into trouble even in the best of situations, and a rising rate environment is less than an ideal environment to be forced to sell off fixed income investments. 

During the pandemic, banks were flooded with deposits as a result of the unprecedented government stimulus, and they invested a lot of those deposits into fixed income securities when interest rates were pegged to the floor by the Fed. As interest rates have risen, that has pushed down the value of those securities. Much like with an investor who buys a bond with the intention to hold it to maturity, the day-to-day change in value shouldn’t matter as long as the security can be held to maturity – which for banks depends on avoiding having a wave of depositors ask for their money back all at once. 

Policymakers at the Fed and the Treasury have hopefully forestalled further panic about the safety of deposits with their response to the recent bank failures. Nevertheless, the events of the past week are still likely to dampen the animal spirits of investors with a renewed appreciation for the risks they are taking.  

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Federal Debt | Snowballing 

March 6, 2023

As Congress marches towards a showdown this summer over raising the federal debt limit, the Congressional Budget Office (CBO) has highlighted the long-term fiscal challenges facing the federal government with its latest 10-year budget projection. 

The CBO makes these forecasts each year assuming current laws remain in place and smooth sailing for the US economy. Not surprisingly these estimates have significantly underestimated how much debt the federal government would accumulate over the coming decade.

In the past fifteen years, the US has experienced a financial crisis and a pandemic – rough seas that led to significant outlays by the federal government. The federal debt held by the public has already topped 100% of GDP, and the CBO projects it is headed towards 200% over the next thirty years. Market-imposed fiscal limits may prevent that forecast from being another underestimate.

The powers-that-be have been able to increase the federal debt with no apparent downside as the Federal Reserve has pegged interest rates at abnormally low levels for most of the past two decades. With interest rates returning to more normal levels, Congress likely won't be able to kick the hard decisions down the road for much longer.       

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Corporate Profits | Normalizing as stimulus wanes

February 27, 2023

With most of the companies in the S&P 500 having reported earnings for the fourth quarter of last year, “only” 68% have exceeded the well-managed earnings expectations of analysts. Over the past few of years, that number has often been greater than 80%. 

During 2022, corporate profitability began to normalize after benefiting greatly from the sizable government stimulus injected into the economy to counteract the effects of the pandemic. Even after retreating slightly, profit margins remain high by historical standards; and yet the consensus expectation is they will rebound higher again this year despite the Fed’s efforts to slow the economy with higher interest rates.

Those higher interest rates in themselves cast doubt on expectations for higher margins. Over the past couple of decades profit margins and corporate bond yields have often moved together with interest rates leading the inverse change in margins by a few months. The most direct link between the two is the fact that lower interest rates ultimately reduce companies’ borrowing costs and vice versa. Indirectly, corporate bond yields are also an indicator of investors’ general confidence in future corporate profitability. 

Current corporate bond yields, which still reflect tight credit spreads to US Treasury debt and thus a high confidence in future corporate profitability, nevertheless suggest that profit margins may continue to decline back towards a more historical level even without a recession. 

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Sources:, Ycharts, Federal Reserve, Moody's Seasoned Baa Corporate Bond Yield,, AOWM calculations

Rising Rates | How high and how long?

February 20, 2023

Recent economic data has suggested inflation may be more stubborn than hoped.   As a result, investors have once again shifted their expectations for how high the Fed will raise interest rates.


Over the past two weeks, expectations for the peak fed funds rate have moved from below 5% towards 5.5%. Long-term interest rates have increased by a similar amount but remain below the levels they reached last fall.


Is it time to shift from fixed income securities with short-term maturities and lock in long-term interest rates? History suggests investors can be patient as long-term rates, especially for corporate debt, haven’t typically begun to decline significantly until the Fed is done raising rates. And if the markets are in the process of slowly adjusting to a new normal of higher interest rates, short-term debt may continue to offer better returns for a while as it did in the 1960s and 1970s.


How much higher and longer the Fed will raise rates is hard to predict, but investors are likely still best served by tilting their fixed income investments towards high quality, short-term debt.

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Banks | Beginning to batten down the hatches

February 13, 2023

Bank lending has remained strong despite the slowing economy, but the number of banks tightening lending standards continues to grow which does not bode well for future loan growth. The demand for loans is also declining as the Fed continues to raise interest rates. 

A retrenchment in available credit could be one of the things that helps to tip the economy into a recession later in the year. And in turn a recession would also likely lead to a de-leveraging of corporate balance sheets. Corporate debt outstanding has grown to a historically high level relative to GDP (~50%). After the recessions in 2001 and 2007-2009, corporate debt as a percent of GDP fell to around 40%.   

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Labor Market | Still beating expectations

February 6, 2023

The jobs report last week was once again better than expected as the labor market continues to hold up well in the face of rising interest rates and a slowing economy. The unemployment rate fell to its lowest level over the past 69 years, and employers were estimated to have add 517,000 new jobs. 

January’s employment numbers took a little steam out of the stock market which has charged higher through its 200-day moving average and last year’s downtrend line. Investors took a breath from their recent bullish run as the strong jobs report makes it more likely that the Fed actually will take interest rates higher for longer. 

The strong labor market unfortunately cannot be taken as a sign that the Fed will succeed in pulling off a soft landing of taming inflation without a recession – which would be the best news for investors. There have been a lot of historical outliers over the past few years; however, it would be the historical norm for employment to remain strong past when the Fed plans to finish raising rates in a few months and then turn south with the economy a few months thereafter. 

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The Market | Fighting the tide

January 30, 2023

The markets have gotten off to a good start in the new year. The S&P 500 index is up over 6%, and the Bloomberg US Aggregate Bond Index is up 3%. To the extent these short-term price moves are indicative of a coherent outlook by investors, it would imply a growing view that inflation will quickly fall to 2%, the Fed will swiftly pivot to lowering rates, and the economy will avoid a recession.

That goldilocks chain of events would be a historical anomaly. It also may not be sufficient to push the stock market much higher. Improving expectations for corporate profits and growing risk appetites fuel strong bull markets; the tide for both is still going out at the moment.  

Even if the Fed was inclined to pivot towards lowering rates, it is far from guaranteed that would improve the short-term outlook for the market. But the potential effect of lower rates is likely moot as the Fed is poised to affirm yet again this week its plans to take short-term interest rates higher for longer. 

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Sources:, YCharts, BEA, PCE inflation, Wall Street Journal

January 23, 2023

Mortgage rates | Lower but still high

Last year mortgage rates spiked from around 3% to over 7%, significantly decreasing the affordability and sale of homes. The past few months have offered a slight reprieve as mortgage rates have retreated towards 6% and may have further to fall as they remain at a historically wide spread to the 10-year Treasury rate; however, high mortgage rates are likely to remain a headwind for the sector.   

The Federal Reserve is clearly being successful in slowing the economy when it comes to the housing market. In addition, data released last week on industrial production and retail sales in December showed other areas of the economy are weakening as well.

Given the growing signs that the economy and inflation are slowing, investors expect the Fed will increase its target fed funds rate by just 0.25% at its meeting next week and stop raising rates at its following meeting in March. 

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Inflation | Mission accomplished?

January 16, 2023

Annual inflation as measured by the Consumer Price Index (CPI) declined for the sixth straight month in December, down to 6.4%. Annual core inflation excluding energy and food also improved, declining to 5.7%.

Over the past three months, inflation has been running below 2% on an annualized basis, and core inflation has been close to 3%. As a result of declining inflation and the rapid increases in the fed funds rate by the Federal Reserve, real short-term interest rates based on core CPI eked backed into positive territory in the last quarter of 2022 after being deeply negative to start the year. 

Inflation is unlikely to take a straight elevator back down to 2%, but it is definitely moving in an encouraging direction which has alleviated a lot of investors’ concerns even if they remain overly optimistic about how quickly the Fed will stop raising rates and reverse course. 

The past few years have highlighted how little is understood about how inflation works, so policymakers are likely to stick to their plans for raising the fed funds rate above 5% for an extend period to ensure that the stake has been thoroughly run through the heart of inflation. If the markets and economy continue to motor along without any great unhappiness, there will be even less incentive for them to do otherwise. 

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Sources:, AOWM calculations

Labor Market | Strong employment, weak wages

January 9, 2023

The labor market remained generally strong in December with the unemployment rate falling to 3.5%. Instead of raising fears that the good jobs report might keep the Fed raising interest rates, investors seized on a slowdown in wage growth as a sign that inflation will continue to abate. While a potentially good sign for inflation, slowing wage growth is likely to add an additional headwind for the economy as wages fail to keep up with rising prices, hurting consumption.

There were also signs under the surface that the Fed is being successful in slowing the economy. The number of new jobs added continued to decline to the lowest level in two years. In addition, the number of employees in temporary help services fell further which has historically been a canary in the coal mine for the broader labor market. 

Investors are holding out hope that inflation will subside without a recession. However, state level data through November indicates that more than half the states are already experiencing negative labor market conditions which has historically implied a pending downturn for the national economy. Despite the positive market response to the jobs report on Friday, the odds of inflation retreating peacefully still don’t appear high. 

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January 2, 2023

2023 | The Outook

Financial markets are coming off their worst year since the great financial crisis in 2008. Last year, fixed income investments suffered their worst year on record as interest rates broke their four-decade downtrend, and stocks suffered their longest prolonged decline in thirteen years. Global financial markets have now shed nearly $40 trillion of their market value. 

Policymakers, professional forecasters, and investors remain generally cautious headed into the new year.  Nevertheless, the consensus outlook is also the best case scenario where inflation declines steadily, but the economy doesn’t slip into a recession (or at least only suffers a very mild one if it does). Inflation that failed to retreat as expected and/or a recession deep enough to weigh on corporate profits would likely make 2023 another tough year for investors. 

With margins still at historically high levels and earnings growth expected to remain strong despite the slowing economy, the potential for disappointing earnings appears to be the biggest risk for the market at the turn of the calendar year. 

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Sources:, Federal Reserve, Bloomberg, YCharts, AOWM calculations

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