Evening Brief – 05.06.24
Is the Worst Over?
The recovery in the major U.S. equity indices in the first week of May has raised hopes that the worst is over, especially following the smaller-than-expected rise in the April U.S. payrolls data released last Friday. Market participants consider the news as a net positive since it increases the likelihood that the Federal Reserve will lower interest rates this year.
Even if the argument is valid, it is not without market risk. Much of it is heavily influenced by how quickly the U.S. economy slows. A bit of cooling would most likely garner a further deceleration in inflation, which has recently printed hotter than expected. However, if the downshift in the economy gathers momentum, it introduces many other concerns for the Federal Reserve.
“It feels a little early to declare that the U.S. economy has made a soft landing since the Fed still is holding interest rates at restrictive levels,” said Comerica Bank chief economist Bill Adams. “But the April jobs report helps clear a path to that destination.”
However, some analysts believe the possibility of the economy contracting faster than expected is substantial. “The reason I think the Fed’s going to see enough to cut [interest rates] is because we’re more toward the hard landing end of the spectrum,” noted Citi chief U.S. economist Andrew Hollenhorst.
Investors are once again shifting their rate-cut expectations. Traders are back to pricing in a 50-50 chance of the first rate cut in September, a sharp reversal from last week.
The U.S. Treasury market is back to trading on a similar dovish path. The U.S. 2-year Treasury yield is trading around 4.83%, a sharp drop from the 5.02% seen early last week.
Of course, there are multiple moving components to assuming a best-case scenario of ebbing inflation and a minor slowdown in economic activity but does not strengthen challenges for earnings and stocks.
Next week’s CPI report will be “informing the path of monetary policy and the market’s pricing of that path,” explains a Morgan Stanley team of analysts led by Michael Wilson in a research note. “The price reaction on the back of this release may be more important than the data itself given how influential price action has been on investor sentiment amid an uncertain macro set up.”
Price action will indeed be key for a Fed that seems in no hurry to cut interest rates. “Early 2024 inflation data has been disappointing to those who thought that the inflation fight was behind us,” said Richmond Fed president Tom Barkin at the Columbia Rotary Club in South Carolina on Monday. “We have said we want to gain greater confidence that inflation is moving sustainably toward our 2% target. And given a strong labor market, we have time to gain that confidence.”