September Outlook: Will Late Summer's Chill Extend To Autumn? Rising Yields, Fed Meeting In Focus

Wall Street entered August sizzling but quickly cooled. Now investors trudge into September—historically the weakest month of the year—wondering if there’s potentially more chill ahead as fall breezes intensify.

September 2022 lived up to its poor reputation as stocks pulled back from their summer rally. This year, the July picnic attracted flies as soon as August began, meaning you could argue September’s icy fingers are already evident. Mega-cap technology and communications services stocks hit a wall after Microsoft MSFT and Apple AAPL reported earnings that failed to enthuse investors. As wind left the sails of those two schooners, nearby boats also took on water.

With earnings season over, September’s arrival shifts Wall Street back into macro mode. Investors will harvest a bumper crop of crucial data in coming weeks leading into the Federal Reserve’s September 19 – 20 meeting, and the question is whether the numbers can convince the Federal Open Market Committee (FOMC) to keep rate hikes tucked away in the drawer at least until November.

As of late August, futures trading priced in just a 20% probability of a September hike but also close to a 60% chance that the Fed isn’t done increasing rates quite yet from the current target range of between 5.25% and 5.5%, a 22-year high.

The Fed’s closely watched Jackson Hole Economic Symposium in late August found Fed Chairman Jerome Powell speaking from both his hawkish and dovish playbooks, but the overall mood on Wall Street seemed to improve after he spoke. While additional rate hikes may be needed to manage inflation, Powell said, he hinted that the Fed could hold rates steady in September and remain data dependent.

Washington budget policy might also come back into view after a relatively quiet summer following last spring’s debt ceiling imbroglio. A government shutdown fight looms in September when Congress returns. Congress has a deadline of September 30 to pass the 12 appropriations bills that fund every government agency and federal program. So far, the House has passed one, and the Senate has passed zero. Both chambers will be racing to get their versions of the funding bills passed by the deadline, noted Michael Townsend, managing director of Legislative and Regulatory Affairs at Schwab. He said chances of a shutdown are high but added that shutdowns in the past haven’t been big negatives for Wall Street. 

Soft landing scenario

No single month has all the answers. Still, following two months of generally encouraging U.S. inflation data for June and July, September’s reports on the August numbers could provide better clarity on whether a so-called “soft landing” is within reach or if the Fed needs to roll up its sleeves and do more work.

Besides the Fed and the coming rate picture, investors have other questions entering September that might be answered in the numbers or by other events. Chinese economic growth sagged this summer, and the latest manufacturing data from Beijing due in early September could provide more clarity into whether recent government stimulus had any impact. Recent retail sales and industrial production data came up short, and the People’s Bank of China executed a surprise rate cut in mid-August.

It’s also worth watching September’s U.S. manufacturing data—under a cloud for months—to get a better sense of whether the U.S. economy might face recessionary trends. Some economists argue that the country has experienced a “rolling recession” in 2023 and say the odds are close to even that a formal recession could begin sometime soon.

“To date, it’s still not clear” whether a recession is near, wrote Schwab strategists Liz Ann Sonders, Kathy Jones, and Jeffrey Kleintop in a mid-August post. “Despite the Federal Reserve’s efforts to cool economic growth and control inflation, job growth has remained relatively strong—although job expansion historically is common at the beginning of recessions. Meanwhile, longer-term Treasury yields have risen sharply in recent weeks.”

Treasury yields will likely remain top of mind throughout September after hitting nine-month highs in August above 4.3% for the benchmark 10-year Treasury note (TNX). Last year, the TNX topped out just above 4.33%, but that was at a time when the Fed was steeply raising rates to fend off inflation. 

June and July Nonfarm Payrolls both came in relatively low at under 200,000 new jobs created. Did August make it a hat trick, and, if so, did lighter jobs growth finally start to ease the cost of labor that economists say can drive up inflation? Early indications going into the September 1 jobs report are for growth of just 170,000, according to Trading Economics, the lowest monthly rise since December 2020.

Things didn’t seem to improve immediately despite Beijing’s efforts, as Chinese stocks continued to pull back on nearly every recent rally. And Barron’s recently reported that Chinese households prefer to save than to spend.

LOSING STEAM: The sharp, quick drop in the S&P 500® index (SPX—candlesticks) and the Nasdaq-100® (NDX—purple line) in early August as Treasury yields soared eased slightly later in the month, but autumn is traditionally a weak season for stocks. Data source: S&P Dow Jones Indices. Chart source: thinkorswim® platformFor illustrative purposes only. Past performance does not guarantee future results. 

Fed meeting draws near as yields climb

This time around, the Fed appears to be near, if not at, its final target range for rates. Momentum turned positive for stocks after Jackson Hole, as Powell said the central bank will “proceed carefully” as it studies fresh economic data.

Whatever the case, the market appeared to like what it heard, with major U.S. benchmarks posting firm gains Friday and breaking a three-week losing streak as Powell’s comments seemed to ease investor concern that further rate hikes may be coming. The TNX pulled back from 15-year highs of 4.37% in late August but remained near 4.2%, so quite high by the standards of recent history.

Some economists said the rally in yields doesn’t reflect inflation fears. Instead, it could be based on recent hefty auctions of Treasuries that infused the market with supply even as the Fed continued its quantitative tightening policy to reduce its balance sheet. These trends tend to push yields up as supply pressures hit the underlying Treasury notes.

As a result, pressure on the economy can increase, especially in rate-sensitive areas like automobiles and homes. Mortgage rates remained above 7% in August. Typically, higher mortgage rates ease housing demand and send prices lower, but shelter costs made up about 90% of the July increase in consumer inflation.

Until housing prices stop climbing so quickly, inflation might continue to flare, making the Fed’s job harder. Fed policymakers could be between a rock and a hard place; they loathe to raise rates high enough to “break” the economy but are fearful that not doing so would allow inflation to persist. July year-over-year core Consumer Price Index (CPI) growth was 4.7%, down from 4.8% in June but well above the Fed’s 2% goal. Core CPI strips out volatile food and energy prices.

Wholesale price growth in July also fed anxieties on Wall Street after a slight increase from June. Most of the increase was in one or two categories, meaning it’s possible the August report reflected a one-time occasion rather than a trend. The CPI and Producer Price Index (PPI) reports for August, due in mid-September, will again be a primary focus for investors. One question is whether shelter costs that long pushed inflation upward will begin to diminish thanks to easier comparisons with year-ago levels.

Before that, the August Nonfarm Payrolls report is due Friday, September 1 before trading opens. Both June and July jobs growth fell under 200,000 to the lowest levels since late 2020. This trend was generally welcomed by bullish investors following much stronger jobs growth earlier this year accompanied by rising wages.

While workers deserve fair pay, the Fed has worried about a wage-price spiral where tighter labor supply and strong demand for workers could cause pay to increase and companies to then increase prices so they can afford the new hires. To date, inflation expectations remain well harnessed, according to the Fed. Still, wages rose 4.4% year over year in July, and the Fed would probably like to see that ease in August.

Meanwhile, July Retail Sales popped 0.7%, well above June’s 0.2% growth and more evidence of a healthy consumer. This fueled ideas that the Fed might have to keep rates higher for longer and pushed back hopes that rate cuts could accelerate after mid-2024 as the futures market had built in.

“Stronger retail sales may not mean the Fed has to hike again but doesn’t support the market’s expectation of five rate cuts in 2024,” noted Sonders, Schwab’s Chief Investment Strategist.

Big boxes get conservative ahead of holidays

While retail sales surged in July, some of the recent big-box retailers reported earnings that raised questions about consumer health. U.S. consumers have run up $1 trillion in credit card debt, the New York Federal Reserve reported in August, driven partially by rising interest rates. This could be starting to weigh on spending decisions.

Retailer earnings numbers for Q2 were mixed overall with few surprises up and down—Walmart WMT delivered, while Kohl’s KSS and Dick’s Sporting Goods DKS appeared to disappoint investors, but almost every big retailer seemed to sound a conservative gong for the holidays.

The Fed has to weigh all these elements as it meets in September. The meeting is also one of four annual FOMC gatherings to provide updated projections on future rates, inflation, unemployment, and economic growth. Back in June, the committee projected the target range to top out between 5.5% and 5.75%, up 25 basis points from the current level, but some members thought it might take 6% to get inflation wrestled to the mat. We’ll find out in September if feelings changed on that front.

Crude considerations

However, one factor basically outside the Fed’s control and the control of investors is the price of crude oil. Its steady ascent since early June shouldn’t be ignored as a reason for the market’s recent pullback, as rising oil costs tend to raise inflation worries.

Crude surged from below $70 per barrel in mid-June to a new 2023 high above $84 per barrel by mid-August, driven in part by OPEC’s production cuts and by surging U.S. demand in an economy that grew 2.4% in Q2. Strong travel demand and generally firm consumer spending amid low unemployment likely played into rising crude costs, along with the hot summer weather that prevented refineries from producing gasoline at full capacity. OPEC isn’t scheduled to have a formal meeting until October.

Typically, the “driving season” ends after Labor Day, which falls on Monday, September 4. For many years, crude oil loses ground into the end of the year, as was the case in 2022. The futures market, which is in “backwardation” with contracts further out at a discount to front-month futures, backs up this scenario. A drop in fuel costs would probably be welcome for most sectors, especially transportation-related stocks like airlines and trucking firms, which came under pressure in August.

Crude eased to around $80 per barrel by the end of August but remains a potential speed bump.

September is quiet on earnings but not without a few highlights. Results from Kroger KROracle ORCL, and Adobe ADBE, among others, are on the calendar.

Seasonal considerations aside, there’s plenty to keep investors anxious about September’s unfriendly reputation on Wall Street. With earnings mostly taking a month off, the geopolitical and yield worries that surfaced in August could remain front and center as autumn’s first breezes blow. 


TD Ameritrade® commentary for educational purposes only. Member SIPC.

Image sourced from Shutterstock

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