As I have long said, the rest of the world is starting to cut rates in June – even if the Fed doesn’t follow suit. The Bank of Canada cut its key interest rate by 0.25% to 4.75% last Wednesday. Then, on Thursday, the European Central Bank (ECB) cut its key interest rate by 0.25% to 3.75%.
Other major central banks that have cut key rates recently include Brazil, Chile, Mexico, Sweden and Switzerland. The Bank of England will meet on June 20th. They originally talked of cutting rates in June, but due to the fact that an election has been declared there, a rate cut may be postponed, so the central bank will not appear partisan.
The Fed was originally planning on joining that group by cutting rates in June, but after inflation started rising again, the Fed decided to postpone its first cut until July or even September 18th. Since our Fed will now be lagging Europe in rate cuts, that means our rates will be higher, so “carry trades” are expected to increase. That’s where foreigners put money in the U.S. dollar, seeking higher yields in a strong currency.
That’s good news for us, since if these carry trades approach a trillion dollars or more, they could actually drive Treasury yields lower and encourage the Fed to cut key interest rates sooner rather than later. As a start, last week, the 10-year Treasury bond yield declined to an intra-day low of 4.272% on Thursday, after these rate cuts overseas, and after weak manufacturing and early job news caused interest rates to decline.
However, in the wake of Friday’s stronger-than-expected payroll report, the 10-year Treasury yield rose back to 4.439%. Specifically, the Labor Department announced that 272,000 new payroll jobs were added in May, which was substantially higher than the economists’ consensus estimate of 180,000. Job gains were broad based in most categories, led by healthcare (68,000 jobs), government (43,000) and leisure & hospitality (42,000).
The unemployment rate rose to 4% in May, up from 3.9% in April and 3.7% a year ago, as more people joined the workforce. Average hourly earnings rose by 14 cents (+0.4%) to $34.91 per hour. There were minor downward revisions to the March (5,000) and April (10,000) payrolls. Overall, the strong May payroll report will likely cause the Fed to hold steady on key interest rates.
In the other major jobs report, ADP reported on Wednesday that private payrolls rose 152,000 in May, which was below economists’ consensus estimate of 175,000 and the smallest monthly increase this year. The manufacturing sector lost 20,000 payroll jobs, the most since January, which is an alarming sign.
The JOLTS (job opening data) on Tuesday came in at the lowest level in over three years. ADP’s chief economist, Nela Richardson, said “The labor market is solid, but we’re monitoring notable pockets of weakness tied to both producers and consumers.” Treasury bond yields meandered lower on this news.
Ukraine, Manufacturing Recession And Other Factors That Could Impact The Election
If interest rates were not a big enough wild card for the stock market, the fall of Ukraine’s second biggest city (Kharkiv, with over 1.4 million people) may be imminent. Russia is striving to cut off power to Kharkiv and make the city unlivable.
Britain and the U.S. have supplied Ukraine with long-range missiles that can strike deeper into Russia, so the fighting is no longer just a border skirmish, but has escalated into a major proxy war funded by NATO.
France is sending military advisors to assist Ukrainian troops, which are increasingly using drones to fight Russian troops. With the U.S. and NATO funding a proxy war with Russia, the probability of escalating into World War III is rising. Now that Ukraine is essentially out of troops and recruiting prisoners to fight, hopefully a cease-fire and peace agreement could ensue.
President Biden was in France last week to give a speech on the 80th anniversary of D-Day in Normandy. Next week, Vice President Kamala Harris and National Security Advisor Jake Sullivan will attend a peace summit in Ukraine that will be held in Lucerne, Switzerland. I suspect that a more serious peace deal between Ukraine and Russia will ensue in the upcoming months since, otherwise, the death toll from the fighting will be intolerable.
The U.S. is still in a manufacturing recession. The Institute of Supply Management (ISM) announced that its manufacturing index declined to 48.7 in May, down from 49.2 in April. Since any reading below 50 signals a contraction, the U.S. manufacturing sector remains in a recession.
The new orders component plunged to 45.4 in May, down from 49.1 in April. The backlog of new orders plunged to 42.4, down from 45.4 in April. Seven of the 14 manufacturing industries that ISM surveyed reported contracting in May.
In contrast, ISM announced last Wednesday that its non-manufacturing (service) index surged to 53.8 in May, up from 49.4 in April. The hottest sub-sector in the ISM survey was its business activity component, which surged to 61.2 in May, up from 50.9 in April.
Also encouraging was its new orders component, which rose to 54.1 in May, up from 52.2 in April. Fully 13 of 18 service industries that ISM surveyed reported an expansion in May. Overall, the ISM service sector report was very encouraging.
Due to this bullish ISM service survey, the Atlanta Fed raised its second quarter GDP growth forecast to a 2.6% annual pace, up from 1.8% in the previous week. Inventory rebuilding and energy exports have been responsible for most of the GDP growth. If consumer spending perks up, GDP estimates should continue to rise.
The real problem with the U.S. economy is that the consumers in the top 20% of income (mostly Baby Boomers) are in good fiscal shape due to the appreciation of stock market and housing assets, while the bottom 20% of income (mostly young people under 30) are struggling. This frustration among young voters is also expected to have profound implications on the upcoming Presidential election.
Bloomberg reported on Tuesday that almost two-thirds of middle-class Americans said that they are facing economic hardship and do not anticipate a change for the better for the rest of their lives, according to a poll of 2,500 adults by the National True Cost of Living Coalition. Ouch!
This mass insecurity is not a good development for President Biden if he wants to get re-elected. The pollsters, the National True Cost of Living Coalition, said that 65% of those surveyed were 200% above the federal poverty level, which represents households earning at least $60,000 per year.
This survey also showed that households making over $150,000 per year also worry about paying their bills! The poll also showed that about 40% of survey respondents were unable to plan beyond their next paycheck, and 46% didn’t have $500 saved.
Right or wrong, this feeling of financial insecurity does not augur well for President Biden’s re-election.
Jamie Dimon Warns that the Private Credit Market Poses Great Risks
For several weeks, I have been writing about the looming risk in the private credit market. Well, now JPMorgan CEO Jamie Dimon agrees, saying that he expects problems to emerge in the booming private credit market, warning that “there could be hell to pay.”
For example, Vista Equity Partners bought Pluralsight, Inc., a workforce development company, in 2021 for about $3.5 billion. This leveraged buyout was supported by over $1 billion of debt financing by direct lenders. Unfortunately, Vista Equity Partners recently wrote off the entire equity value of Pluralsight as its debt service costs soared.
In an effort to make a $50 million interest payment coming due, Pluralsight moved its intellectual property into a new subsidiary and used those assets to obtain additional financing from Vista Equity Partners. Whether or not this private debt Band-Aid will hold is highly questionable.
The syndicate leaders behind the $1+ billion of debt supporting the Pluralsight leveraged buyout are a “who’s who” in private credit, including Ares Management, Benefit Street Partners, BlackRock, Blue Owl Capital, Goldman Sachs Capital Management, and Oaktree Capital Management.
In my opinion, the 11% yields that the private credit industry pays investors are not sustainable, and as Pluralsight demonstrates, bad loans could potentially “prick” the $2 trillion private credit bubble. The Fed may have to rescue the private equity industry if one big failure causes a run on private equity assets.
In the meantime, due to rising credit risk, I recommend that you avoid private credit sold by companies like Ares Management, Benefit Street Partners, BlackRock, Blue Owl Capital, Goldman Sachs Capital Management, and Oaktree Capital Management.
Navellier & Associates does not own Ares Management (ARES), Benefit Street Partners (FBRT), BlackRock (BLK), Blue Owl Capital (OWL), Goldman Sachs Capital Management (GS), and Oaktree Capital Management (OAK), in managed accounts. Louis Navellier does not own Ares Management (ARES), Benefit Street Partners (FBRT), BlackRock (BLK), Blue Owl Capital (OWL), Goldman Sachs Capital Management (GS), and Oaktree Capital Management (OAK), personally.
All content above represents the opinion of Louis Navellier of Navellier & Associates, Inc.
Disclaimer: Please click here for important disclosures located in the “About” section of the Navellier & Associates profile that accompany this article.
Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.
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