Schwab Market Perspective: On the Line

Meanwhile, longer-term Treasury yields have risen sharply in recent weeks. While this traditionally is a sign that markets expect stronger economic growth in the future, we think there are other factors currently at work in the bond market: namely, increased bond supply and the potential for lower demand from Japanese buyers.

Finally, the global economy seems to be transitioning out of "stagflation" (low growth and high inflation), to just stagnation as the pace of economic growth and inflation is slow enough to end the rate hiking cycle in most major economies.

Labor data can often look confusing at economic inflection points. One of the widely held myths around the labor market and recessions is that data don't look poor when a recession begins. That isn't the case, however, when looking at payroll gains at the start of historical downturns. As shown in the table below, out of the 11 recessions going back to the 1950s, nine of them began as the economy was still adding jobs.

Confidence among CEOs was one of the first areas to slip into a recession. Yet now, as shown in the chart below, executives are increasingly optimistic that the worst might be behind us. A continued improvement should bode well for businesses, but it's worth noting that 84% of respondents in The Conference Board's CEO confidence survey said they still expected the economy to enter a recession during the next 12-18 months (although that was down from 93% in the previous survey).

Concerns about finding buyers for U.S. debt were also complicated by the Bank of Japan's recent decision to allow its government bond yields to rise for the first time in decades. Because Japan historically has been a large buyer of U.S. Treasuries, any change in the attractiveness of Japan's domestic market relative to the U.S. market could be significant. Consequently, Treasury yields are rising to attract buyers at a time when there is potentially less demand and more uncertainty about how high the Federal Reserve will hike rates in this cycle.

Despite these challenges, we don't see yields moving sharply higher from current levels. Much of the negative news appears to be priced into current elevated real yields. In the long run, the direction of yields is driven by prospects for growth and inflation. Indications point to inflation continuing to decline, as the effects of the Fed's policy tightening to date work its way through the economy.

Credit conditions have tightened, which is starting to show up in a slower pace of consumer borrowing and rising delinquency rates on auto loans and credit cards.¹ In addition, the pace of job growth and wages is slowing down as the labor market cools off. On the global front, weak manufacturing and trade data in Europe and China² suggests a slowdown in demand for goods and services, especially commodities, is unfolding.

Because G7 economies have more service jobs than manufacturing jobs, a weakening trend in services could undermine the job market that has supported consumer confidence. Notably, Canada reported job losses in two of the past three months. The commentary from business leaders on earnings calls so far this reporting season has mentioned layoffs more often than labor shortages. For example, recent layoff announcements have come from a wide range of industries including drug store chain CVS Pharmacy, AB InBev (the parent of Anheuser-Busch), biotech company Biogen, mobile phone chip maker Qualcomm, and money manager T. Rowe Price.

Using equal-weighted versions of the same indexes, measured in U.S. dollars, the outperformance by the average European stock is even more impressive, with a total return of nearly 17% year-to-date, compared with the average U.S. stock total return of 10.7%.