Equities Unfazed by Shifting Rate Expectations
The S&P 500 has advanced thirteen of the last fourteen weeks, propelling the benchmark index to all-time highs, trading a whisker away from the symbolic milestone of 5,000. It has gained more than 21% since the end of October, driven by the promise of Fed rate cuts, better-than-expected economic data, and blowout earnings from several mega cap technology stocks. Bond markets, however, have not enjoyed a similar start to 2024 as stocks: with the 10-Year U.S. Treasury yield jumping 28 basis points over a two-day period earlier in the week, the largest such move since June 2022. At the most recent Federal Open Market Committee meeting, and again on 60 Minutes, Fed Chair Jerome Powell pushed back against the idea of the Fed beginning to ease the policy rate in March, a move that markets were overwhelmingly expecting. Powell stressed that the “danger of moving too soon is that the job’s not quite done,” and “the prudent thing to do is to just give it some time and see that the data continue to confirm that inflation is moving down to 2% in a sustainable way.” He added that he expects three 25 basis point cuts to the 5.33% effective Fed Funds rate this year, half the number of cuts priced in by interest rate futures last week.
Recent economic data reinforces the Fed’s caution that inflation has not quite been subdued. Friday’s non-farm payrolls print for January showed a 353,000 increase in employment, nearly double the 185,000 consensus estimate. Then, on Monday, the Institute for Supply Management’s (ISM) survey for January showed the largest monthly acceleration in prices paid in more than a decade. ISM said the recent rise in inflation has been primarily driven by higher shipping costs and increases in commodities and services prices.
The global shipping industry has been hit with a substantial reduction in supply thanks to the current predicament in the Red Sea. As a result, voyages take 40% longer to circumnavigate what is normally one of the busiest trade routes in the world. The IMF issued a report that estimates “that the doubling of freight rates leads to a 0.7 percentage point increase in inflation, with the effects peaking after a year and lasting up to 18 months.” Just as supply constraints were a major cause of the prior inflationary surge, similar circumstances are emerging.
The U.S. Treasury market cleared a major hurdle this week with the successful completion of its quarterly debt refunding. The massive issuance of $121 billion of longer-maturity notes and bonds was a key test of investor willingness to absorb supply. This is especially noteworthy given that regional bank angst has reentered the conversation as New York Community Bank reported a surprise loss last week and announced a cut to its dividend. The bank’s loan-loss provision swelled to $552million in the fourth quarter to cover troubled loans tied to commercial real estate, more than 10 times the analysts’ estimates. Moody’s subsequently has cut their credit rating to junk and the stock is now trading at its lowest level since 1997.
The timing of this year’s ultimate policy pivot will be particularly challenging for the Fed. Economic data has proven resilient, but if they wait too long to begin cutting, they will be thrust into election-year politics and want to avoid any appearances of partiality. U.S. stocks, which began their march higher late last year on the premise that the Fed was going to begin cutting rates earlier than expected, have not reacted to the change in narrative that rate cuts won’t begin until later in the year, and the absolute level of rates will remain higher. Chinese stocks on the other hand have been in a downward spiral as their economy struggles to get out from under high levels of debt and overspending on a property construction bubble that has led to a considerable crisis. Tomorrow’s CPI revisions will be closely monitored by markets. Fed officials are wary of revisions higher that could test the progress made on restoring price stability.
Ryan Babeuf, CFA
Market Strategist
Ryan.Babeuf@EdgeWealth.com
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