Market Commentary

• The decision to cut rates this month will likely come down to what two reports, the August employment report and Consumer Price Index (CPI), show.
• But financial markets have more to be concerned about than just the Federal Reserve (Fed) decision.

We know the financial media has been talking about the upcoming September (16-17) Federal Open Market Committee (FOMC) meeting ever since the Fed held its last meeting in July and the target rate did not change. We were reminded of this month’s meeting again when Fed Chair Jay Powell spoke a couple of weeks ago at the Kansas City Fed’s annual Jackson Hole Symposium. Note that the market is convinced the Fed is going to cut as the federal fund futures are pricing in a 92% probability of a 25 basis point (100 basis points equal 1.00%) reduction at the time of this writing.

But there are several factors at play that markets are thinking about. To begin, between now and the next Fed meeting, we will see the August employment report (tomorrow) and then next week’s inflation reports, including last month’s CPI and Producer Price Index (PPI) data. Chair Powell and other Fed members have been reminding us that they are “data dependent.”

What that ultimately means is the decision to either cut rates this month or hold pat will likely come down to what these reports, particularly the employment report and CPI, show. A weaker labor market would likely trigger a cut. The Fed has been very focused on the labor market, even with what many would consider to be a low unemployment rate, at least by historical standards. As far as CPI, readings in recent months have been trending higher and remain above the Fed’s longer term average target of 2%. Market participants appear to believe the Fed would cut, even with higher than desired inflation, if the labor market slips further.

But financial markets have more to be concerned about than just the Fed decision. The U.S. Congress needs to have next year’s budget approved or pass a continuing resolution to extend current spending levels before the new fiscal year starts on October 1. In addition, a number of other countries, including the United Kingdom and France, are facing deficit concerns as their budgets have been proposed and then analyzed by investors. Deficit concerns have created political stress and pushed longer term bond yields to multi-year highs in these countries, as well as a number of other developed economies including Germany. In the U.S., deficit funding concerns have helped push the yield on the 30-year Treasury bond up over the last month to nearly 5% but the U.S. 10-year note yield has remained in a relatively tight range over the past four weeks. We believe bond investors are focusing on the long-term sustainability of current deficit growth rates. Meanwhile, the U.S. economy is slowing, which puts some downward pressure on yields.

The market is waiting for more data to resolve the cross-currents on yields. For now, we expect volatility in yields and prefer intermediate fixed income (3-7 year maturity range), whose returns are less rate sensitive compared to longer dated securities. More broadly, as the cross-currents spill over into profit, taking in equity markets, our equity focus is on quality large- and mid-cap equities, and we are trimming from small caps, as well as the Communication Services sector, as we see these areas fully valued after the robust rally since the early April lows. Moreover, as short-term rates fall and long-term rates rise, we have downgraded the Energy sector to reallocate to Financials.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector.

Consumer Price Index (CPI) produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.

Producer Price Index (PPI) is a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability or best interest analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee to its accuracy or completeness.

Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors.

Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company.