“Well, Hmmmm”

“Hot town, summer in the city
Back of my neck getting dirty and gritty
Been down, isn't it a pity
Doesn't seem to be a shadow in the city

All around, people looking half dead
Walking on the sidewalk, hotter than a match head

But at night it's a different world
Go out and find a girl
Come-on come-on and dance all night
Despite the heat it'll be alright

And babe, don't you know it's a pity
That the days can't be like the nights
In the summer, in the city
In the summer, in the city…”
(“Summer in the City”, by The Lovin Spoonful)

“Wait…What?”:“An exclamation when someone suddenly realizes something isn’t right.”

It is interesting how quickly market narratives can change. Just a month ago the “consensus” was the economy was expanding, market complacency reigned, and the stock market would just keep going up.

We, of course, have been concerned for several months with overly low volatility, frothy market valuations, an extremely “narrow” market rally (led by the “FANG” stocks – Facebook, Amazon, Netflix, and Google (Alphabet)), and a flattening yield curve that suggested that both the economy and inflation were slowing down.

It appears that market consensus may be slowly catching up to us. Forecasts are suggesting a much lower Q3 GDP (the Wall Street Journal consensus estimate shows US GDP dropping from 3.0% in Q2 to 2.5% in Q3). Further, driven by sharp declines in housing and construction spending, the New York Fed’s “GDP Nowcast” suggests Q2 growth of only 1.9%, falling to 1.5% in Q3. Inflation fell slightly in May (as measured by CPI and reported by the Bureau of Labor Statistics), and is now up 1.9% over the past 12 months – positive but barely within the Federal Reserve’s target range of 2.0%.

The US yield curve continues to flatten, and perhaps even threatens to invert (when short term rates are higher than long term rates – rarely a good omen for the economy), with only a roughly 0.75% differential between 10-year rates and 2-year rates. The Fed, as expected, raised rates again in June, and continues to forecast at least one additional rate hike in 2017. But the markets (as measured by Fed Funds Futures trading) show distinctly lower expectations than just 4-6 weeks ago. The narrative has shifted from the Fed trying to get ahead of inflationary pressures to building in some capability for policy response if / when the current economic expansion ends.