Government Shutdown Drives Reliance on Other Data

KATHY JONES: I'm Kathy Jones.

LIZ ANN SONDERS: And I'm Liz Ann Sonders.

KATHY: And this is On Investing, an original podcast from Charles Schwab. Each week we analyze what's happening in the markets and discuss how it might affect your investments.

LIZ ANN: Well, Kathy, we have said many times, blissfully, on this show, that we are not a political podcast. We don't want to be a political podcast. But on that note, a quick plug, please check out our colleague Mike Townsend's podcast, WashingtonWise, for all things politics and policy. But of course, there are many times, especially in a year like this, when political decisions, or maybe lack thereof, are driving so many of the economic indicators and trends that we follow.

And as we are taping this, the federal government is still shut down. And of course, we don't know how long this particular shutdown will last. So, not just the shutdown, but you've got the lack of employment data, and that feeds into expectations around Fed policy. And so I guess my just broad question to you is, so far, how is this affecting your part of the world, the fixed income side of things?

KATHY: Yeah, it's been remarkably quiet. Now it was relatively quiet going into the government shutdown. We hadn't really seen a lot of volatility in the market, despite all the shenanigans around the budget and everything going on. And what we have, though, is a market that's gone very quiet. The MOVE index[1], which is an index compiled by Merrill Lynch that measures expected volatility in the bond market is down to about a four-year low.

So that tells you that the market is very, very quiet right now, despite everything going on. So you've seen yields kind of just hover here. If you have a lack of reliable data, what do you do? You know, you use the other data, and you make some assumptions, but I'm not sure confidence level is super high in some of the other measures that we've been relying on to give us direction. Then you have the fact that we've had dozens of Fed speakers come out and they don't agree with each other. So we know… we have the general sense that they're inclined to ease policy, but it doesn't seem that everybody's on the same page about it. So how do you take direction from that?

The economic data outside of the labor market is kind of softening, but the market's already discounted several Fed rate cuts as a result of that, while the inflation numbers are high. So there's nowhere to go here, I guess, is what I'm getting at, without more definitive information. 

One sort of public service announcement I'll make if you're a holder of Treasury Inflation Protected Securities, otherwise known as TIPS, there is an adjustment that's made based on the CPI, the Consumer Price Index. If this shutdown continues and we don't get the Consumer Price Index next month, the Treasury that issues the securities has a workaround where they'll just take the previous month's month-to-month increase and assume that that is happening in the current month and will apply that until they have real data. 

I don't think there's anything to be overly concerned about in the market, but just FYI, you know, if you have some volatility in some of those securities, that would probably be the reason, because we'll have to then go back and readjust, and you could see some jumping around there. So something to be aware of. But otherwise, it just seems as though the market's kind of on hold, waiting to see how this all plays out, because for the bond market, all these things matter, not just the data, but what is done with the budget.

Obviously, that has implications and doesn't look like anybody wants to stick their neck out. How about you, Liz Ann?

LIZ ANN: Yeah, so, you know, not a lot of volatility in the equity market, a bit of a shrug, but that is actually, to some degree, in keeping with what has happened in the past. I think we've had 21 shutdowns prior to this one, going back to the mid-1970s. And if you look at the market performance during each shutdown, which obviously those vary in terms of number of days they lasted, but one of the things I added to that data that we have is looked at the one-month lead-in to shutdowns, given that you tend to have some advanced notice and the market is a leading indicator. And you had a whopping 0.1% average change in the equity market in the one-month lead-in and also during the shutdown. So a bit of a ho-hum, not to mention the fact that at times where you've had a little bit more movement, there's plenty of other things that could explain it aside from just the shutdown.

But to your point, Kathy, it's the absence of economic data in an environment where the market is so focused on that, especially as it relates to the Fed's reaction function. And that's why all of us are now deep in the weeds of trying to figure out, "OK, what are the other sources for data, especially tied to the Fed's dual mandates? What are the other labor market sources? What are the other inflation-oriented sources?" And the good news is is there's a decent amount of those even if they're not perfect proxies for the, you know, Bureau of Labor Statistics establishment survey, from which we get payrolls on a monthly basis. But you've got the ADP, Automatic Data Processing, reports that come out on a monthly basis. They've been doing that for quite some time. Individual months are not good forecasts for what we ultimately get with non-farm payrolls, but if you use ADP in a smooth way, look at a three-month average or look at a six-month average and do the same with the non-farm payrolls, they track pretty closely. And for what it's worth, trends in ADP tend to lead trends in non-farm payrolls. So we'll have reliance on measures like that. 

Carlyle just came out with a brand-new jobs metric just today. You've got another organization called Revelio. I guess one of the problems is ADP showed, in the last month, showed a loss of 32,000 jobs. Revelio showed a gain of 60,000 jobs, and Carlyle came in somewhere in the middle at a gain of 17,000. So depending on whether you have a pessimistic view of the labor market or an optimistic view, some of these, you know, private sources for information, you know, pick your poison and you can support your case. So that'll continue to be a bit of an issue, you know, on the inflation front, but also on the labor market front. You mentioned the Fed.

We're still getting Fed data. We're still getting regional Fed data. So embedded in there is information on the inflation backdrop, on the employment backdrop. We're still getting the Purchasing Managers Indexes. So you had the Institute for Supply Management version of those come out. That's the ISM. There are prices paid components. There are employment components. S&P Global also has their version of the PMIs. They have pricing data. They have, you know, labor market data. 

And then maybe an important one coming up is the National Federation of Independent Business, NFIB, which covers most small businesses. And given that small businesses are the net job creators in the country, I think that data maybe takes on a little bit more importance. And there's a lot of embedded sub-components of that survey, including "What's your biggest problem?" And that's where concerns about pricing, concerns about tariff policy, and taxes, and regulatory policy come in. So again, maybe a bit more of a spotlight on those data points. 

And then lastly, and this ties into thoughts on the equity market, obviously we're we're approaching in short order the start to earnings season, and I think for lots of reasons earning season is particularly important right now, but even more so in the absence of government-issued economic data. And you might find that analysts on the conference calls are asking more macro-oriented questions, even specific to individual companies, to get a sense of what the health of the economy is right now, in the absence of that absence of that government data. So I'll be paying a lot of attention to that data. 

One thing I wanted to mention that you and I were just on a webcast just prior to this and I touched on it a little bit is, as another example of some of the bifurcations that are occurring within the economy, you know AI versus non-AI, higher income folks versus lower income folks, manufacturing versus services. There's also bifurcations from an earnings standpoint and the earnings season we're approaching is for the S&P 500, which is obviously not every company in the United States. Now, embedded in the GDP data that we get, we've got the recent positive revision to second quarter real GDP. It went from 3.3% to 3.8%. A lot of that was driven by stronger consumption data. So that's all good, but we also get the National Income and Product Accounts version of corporate profits, NIPA profits as it's called. And that's a much broader measure of corporate profits than just the S&P 500 because it includes smaller companies, it includes S-corporations. And for what it's worth in the first half of the year, the revisions down to after-tax NIPA-based profits, in year-over-year terms, took that into negative territory: minus 1.7% and minus 3.3%. 

That's obviously in stark contrast to the double-digit earnings growth that was experienced by S&P companies in the first half of the year. So the profit story is also one where there's bifurcation, where smaller companies, especially companies that are impacted by tariffs, they have less flexibility, less ability to be nimble and figure out sourcing than larger companies and the larger companies also are bigger net beneficiaries in terms of the AI-related capital spending. So that's just something to keep in mind during earnings season is that we have the large companies on the one hand and smaller companies and the bigger economic story is obviously a combination of both.

KATHY: Yeah, we see that a lot and we focus on that a lot when we look at the corporate bond market and we are seeing a dispersion of performance between the weaker, smaller, lower-rated companies in the high-yield market versus even within the high-yield market, higher rated. So the BB's versus the CCC's, we're seeing a real difference in terms of performance and then obviously relative to the investment-grade market where you have the bigger companies tend to have stronger balance sheets. 

But we follow those NIPA profits pretty closely and it is the first time now in quite some time that they have actually started to move lower, now albeit off of all-time highs, so you know we're not terribly concerned about credit quality in the investment-grade area. Investment-grade corporate bonds have been also a very, very quiet market for quite some time.

And if we see a continuation of this kind of economy, I think we start to see some of that dispersion of returns where the lower-rated high-yield market starts to underperform. But it hasn't happened yet, despite all the things that have been going on, because those yields are still pulling in buyers. But our experience has been in the past, when it catches a hint of something going wrong, it starts to move very fast. So we're keeping a close eye on that. But you're right, there's a lot of nuance below the surface in all these markets. And we're just kind of waiting to see some of the political developments, I guess, on the budget and spending and all that to figure out where we go from here. It's a little more complicated than the calmness on the surface would tend to indicate.

LIZ ANN: Speaking of the absence of the data and the government, so this is the time in this somewhat shortened episode for the look ahead. We don't know if and when the government opens back up. But, you know, aside from government-released data, which we will not get as long as the government stays shut down, what else is on your radar?

KATHY: Well, we should be getting, as we speak fairly soon, the minutes of the last Fed meeting, which should be very interesting because you had the release of the summary of economic projections and that big wide gap between, you know, Stephen Miran, who apparently put in the low dot and the people have the higher dots. And it will be interesting to see what the conversation was and how they shared what's happening in their regional districts to come to the conclusion that they did. So in the absence of actual data that's more forward looking, I'll be very curious to see what those conversations were like. 

The other thing in keeping an eye on is global bond yields. So we've had a lot of stuff going on globally. Elections in France and in Japan have so shaken up expectations for fiscal policy, and that's affecting their bond markets as well.

So, if you're very optimistic about bond yields falling in the US, I think you have to take a pause and say, "But if they're moving up in much of the rest of the world, how much can the US go down?" especially if the economy is still growing and we're not at the verge of recession. So keeping a sharp eye on that simply because it's not the biggest factor for the US bond market, but it is a factor that can influence where our yields go, or certainly the magnitude of yield change in the US. So, I think those are going to be two very interesting stories because fiscal policy is becoming pretty important in the global bond markets.

And how about you? What's on your radar?

LIZ ANN: Well, I mentioned the NFIB small business survey. So that's on my radar. We get the University of Michigan consumer sentiment data out there that has not just consumer sentiment, but there's sometimes interesting nuggets and verbatims from companies. We also get inflation expectations in there, at least one measure of them. We get the housing market index, which is put out by the National Association of Home Builders. And there had been some hope that we were seeing some signs of bottoming in the housing market. But it's in fits and starts. So I'll pay some attention to that.

We're not likely… well, we won't get retail sales data unless the government opens back up and that, in addition to the Consumer Price Index and the Producer Price Index, is kind of a bummer in this kind of market backdrop or economic backdrop to not get that. But one of the things that I started to track, and I started doing this even in advance of the government shutting down, is… Bloomberg provides access to weekly retail sales data at the category level, and they do it by gathering card transactions, both credit card and debit card transactions. And one of the things that I've started to do is look within, at the category level, at tariff-impacted segments and non-tariff-impacted segments, not just in terms of things like pricing, which we try to glean in the absence of broad aggregate government-issued inflation data,

but maybe equally important is any demand destruction we're seeing shifting in behavior on the part of consumers. 

And for what it's worth, the areas within retail sales at the category level using this weekly card-based data show that some of the goods that are impacted most directly by tariffs, like clothing and furniture and appliances and sporting goods, you are seeing some demand destruction. So I think that category-level detail is really important to get a full sense of some of these policies and the impact it's having, both on the pricing side of things and the demand side of things.

That's it for us this week. Thanks as always for listening. And you can keep up with us in real time on social media. I'm @LizAnnSonders on X and LinkedIn. Be wary of imposters on X, but also on many of the other platforms that I'm not actually active on.

KATHY: And I'm @KathyJones, that's Kathy with a K on X and LinkedIn. And as a reminder, you can always read all of our written reports, including the charts and graphs at Schwab.com slash learn.

LIZ ANN: And if you've enjoyed the show, we'd be so grateful if you would leave us a review on Apple Podcasts or a rating on Spotify or feedback wherever you listen, or tell a friend or two or even more about the show. And we will be back with a new episode next week.

For important disclosures, see the show notes or visit schwab.com/OnInvesting, where you can also find the transcript.

[1] "What's the MOVE Index and Why It Might Matter" https://www.schwab.com/learn/story/whats-move-index-and-why-it-might-matter