LET’S GET LOUD

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Despite Tape Bombs, Markets Calm Since Geneva  

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Soundbite: Ask any investor who has traded stocks over the last three weeks if the markets have been volatile, and the answer would be a resounding yes. Yet, markets are holding in a tight range, pulled between hopes for improved earnings revisions and the overhang of higher interest rates. Interest rates hold the key to longer-term market direction. Rally intact above 5650 in the S&P 500.  

The Geneva trade discussions drastically reduced tariff uncertainty and created a reversal in consumer, corporate, and investor sentiment. However, after the dramatic 150-point pop in the S&P 500 on that news, and with stocks lurching after each trade reversal from the President, the index closed Friday only 100 points over the ensuing three weeks.  

The president has been speaking loudly, but the markets have been muted. Normally, after a huge run-up, a tight range is a sign of bullish continuation. 

For markets to continue higher, companies must start speaking loudly in terms of:  

• Higher earnings guidance 

• Improved capex outlook, and 

• Robust hiring plans.  

That can only happen if the administration takes definite steps toward resolving tariff uncertainty.  

We believe the key to equity market direction is the 10-year yield. Last week, we highlighted a Fitch Ratings report that pointed out potential problems lurking in private equity, created by aggressive commercial bank lending to the asset class. They concluded that if rates rise or the economy weakens, potential problems that are being ignored may command investors' attention again. Abandoned themes include the $500+ billion in unrealized interest rate losses sitting on bank balance sheets and the now forgotten problem of commercial real estate. If rates continue higher, any one of these three can come back to haunt us, and investors will start complaining raucously.  

Markets have given the Trump platform the benefit of the doubt, rallying over 20% in less than two months. The rally has been supported by GOP Congress members who are suddenly open to fiscal largess to counter any recessionary tariff impact. German stocks have rallied 30% over the same time, supported by their fiscal stimulus. The Dax index ended the week with an ominous chart pattern formed by a failure after making a new high. If downside volatility develops this week (perhaps triggered by US nonfarm payroll data), bears will start to speak up.  

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Buy Now Pay…? 

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Soundbite: There is an emerging pattern of defaults led by credit card and student loans. Buy now pay later loans are also showing signs of stress, another indicator that the economy is weakening. Credit card interest rates could be a swing factor, since pay-later loans are often used on top of subprime consumers’ credit card debt.  

The New York Fed Household Debt and Credit report for Q1 showed total household debt reaching a new high of $18.2 trillion. Currently, 4.3% of all household debt is considered delinquent; however, loans labeled seriously delinquent (more than 90 days outstanding) have not yet spiked, but are beginning to accelerate, as is typically the case right before credit troubles. Defaults are turning up in mortgages, home equity loans, and credit cards. Student loan delinquencies saw a large jump due to the end of the moratorium on repayment since the pandemic. Credit card debt that is over 90 days delinquent has risen to levels not seen since the 2008-2009 Global Financial Crisis.  

We like to look at marginal borrowers as a leading indicator for a sharp rise in defaults, and buy now, pay later (BNPL) loans can serve as an early warning. More than two-thirds of BNPL borrowers are classified as having risky credit scores.

A Lending Tree survey found that 41% of those using BNPL loans were late on at least one loan, versus 34% in 2024. Klarna, one of the larger operators, reported 19% growth in revenue from interest charges and a 17% rise in credit losses; while these figures are high, there are no red flags yet. However, since the debt default acceleration reminds us of 2007, on the doorstep of the 2008 recession, we are on alert.

With everyone watching tariffs and the tax bill, loan defaults could be the dormant factor that suddenly catches the attention of the equity market. 

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Call 899 

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Soundbite: An incendiary measure in the tax bill calling for increasing the tax on interest and dividends for foreign holders will probably pass because tariff revenue is less certain to offset tax cuts. This will reduce foreign demand for U.S. equities and bonds at a time when those institutions are already shifting asset allocation away from the U.S.  

Call it pouring gasoline on a fire. Last week, Allianz Global Investors, with $650 billion in assets, wrote, “The U.S. may no longer offer the reliable investment runway it did just months ago.” The “Enforcement of Remedies Against Unfair Foreign Taxes” or Section 899 provision of the tax bill will be seen as particularly unfavorable tax treatment by foreign investors. It has the potential to damage the reputation of the U.S. as maintaining free, fair, and open capital markets. This is yet another negative influence contributing to the unraveling of the “American Exceptionalism” trade. 

This move would dampen demand for U.S. assets and was a major reason the dollar fell last week. Deutsche Bank summarized 899 as “the most wide-ranging adverse change to the tax treatment on foreign capital in the US since the Deficit Reduction Act of 1984.” 

Section 899 will be used as a lever to achieve our budgetary goals and increase the federal income tax on passive income by 5% up to 20% above the current rate. That means foreigners would need 10-year Treasury yields to rise by 25 basis points to as much as a full percentage point, to offset this tax hike. The expectation is that foreign demand for Treasuries will still exist even with this tax, and the additional revenue will help narrow the deficit. The problem is that the administration is making bonds less desirable to foreign investors, just as they are needed more than ever to finance our record deficit, which is only going to widen after the tax bill is passed.  

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What to Look for This Week  

(All times D.S.T.) 

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1. Friday, June 6 at 8:30 a.m. May Nonfarm Payrolls. Average Hourly Earnings has been trending down, with the last two readings at 3.8%, the lowest reading in almost 4 years except for 3.6% last June. Thursday, June 5 at 8:30 a.m. we will find out if the 4-week moving average of Initial Claims is going to continue rising. For the week ending May 17, claims data hit a 6-month high.  

2. Tuesday, June 3 at 10:00 a.m. the Job Openings and Labor Turnover Survey for April (always lags payrolls by a month) is released. We are watching the JOLTS Hires Rate, which has been locked at 3.4% since December. Thursday, June 4 at 7:30 a.m. Challenger Job Cuts for May. March showed an enormous spike to 275,000 before falling back to 105,000.  

3. Wednesday, June 4 at 10:00 a.m. May Institute for Supply Management Services Index. Focus on the Services Prices sub-index, which hit its highest level since January 2023 last month. Monday, June 2 at 10:00 a.m. ISM Manufacturing Prices were released. They moved from 40 in January 2023 to last month’s May reading of 70. 

FOMC Voters Speaking: Blackout period starts Saturday, June 7, into the Fed meeting. Fed Governor Christopher Waller spoke last night, affirming his views that tariffs will be a one-time event allowing for rate cuts later this year. At 1:00 p.m. today June 2 Fed Chair Jerome Powell is scheduled to give remarks. May not discuss policy but it will be his only opportunity to speak before the blackout period after his meeting with Trump last week. Philadelphia Fed President Patrick Harker speaks Thursday June 5 at 1:30 p.m. He is a nonvoter, but the topic is the Economic Outlook, and he is the last speaker before the blackout period, which can be of significance. 

Prior to Powell on Monday at 12:45 p.m., Chicago Fed President Austan Goolsbee speaks in a moderated Q&A session. Wednesday, June 4 at 8:30 a.m. Fed Governor Lisa Cook, and non-voter Atlanta Fed President Raphael Bostic take part in a “Fed Listens” event where they hear from the business community.  

The ECB rate meeting is Thursday, June 5, with the expected 25 basis point reduction announced at 8:15 a.m. and the press conference scheduled for 8:45 a.m.  

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