Evening Brief – 04.25.24
It’s Getting Interesting
Equity bulls have experienced a difficult April so far, with most major indices down around 3%. However, it is still too early to tell if risk-on sentiment has peaked or is in a holding pattern that will allow markets to consolidate gains made since October.
The return of inflationary pressures is a significant element that could cause problems for equities. So far, stocks have remained quite resilient. However, a continued rise in U.S. Treasury yields will undoubtedly cause larger headwinds.
Today’s growth and inflation data spooked the markets in that regard. The release of US GDP for the first quarter revealed a surprise drop in growth to 1.6% (estimates were for 2.5%), more than 50% lower than the 3.4% growth rate seen in the fourth quarter of 2023 and the lowest rate since the second quarter of 2022.
Meanwhile, the GDP Deflator (price index) rose to 3.1%, exceeding the 3% forecast and nearly doubling the 1.6% in the fourth quarter. The critical core PCE for the first quarter rose from 2% to 3.7%, far exceeding expectations of 3.4%. We will have a more accurate core PCE report for March on Friday.
“The hot inflation print is the real story in this report.” If growth continues to slowly decelerate, but inflation strongly takes off again in the wrong direction, the expectation of a Fed interest rate cut in 2024 is starting to look increasingly more out of reach,” Fitch economist Olu Sonola commented on the release.
As for equities, most technical indicators do not flash DEFCON-1 type warning signs. The major indices are still above their 100-day moving averages, breadth is holding up, and positioning is becoming more balanced, implying that the recent decline has been relatively mild – some would say it’s needed.
However, the bond market continues to be a negative outlier in the present environment. On Thursday, the US 10-year yield reached its highest level in five months, at 4.70%, while the US 2-year yield broke above the psychological 5% mark. The latest pop in Treasury yields indicates that US fixed income remains squarely in a risk-off mindset.
The possibility of reflationary risks percolating is an important component of the bond market. The rising ratio of inflation-indexed Treasuries (TIPs) to medium-term government bonds (IEF), for example, indicates that the bond market may continue to experience headwinds.
“The Fed is more likely to focus on inflation than growth, and the price index, especially the core price index, doesn’t offer any comfort on that front,” said Sebastian Boyd, Bloomberg analyst.
Rising Treasury yields have caused negligible collateral damage to the equity markets so far. However, if yields continue to climb, it is difficult to believe that stocks can hold up.