The Feds situation is undoubtedly getting more difficult.
The market is facing unfriendly inflation data, especially Wednesdays CPI. Core prices are moving in an undesirable direction. In March, both overall CPI and core CPI increased by 0.4% month-on-month. The annual CPI growth rate increased from 3.2% last month. to 3.5%, the core CPI annual growth rate remained at 3.8%, of which energy increased by 1.1%, services increased by 0.5%, rent increased by 0.4%, and the super core CPI rose again by 0.65% month-on-month.
This is the third consecutive time that core CPI has exceeded expectations, making the gradual slowing of inflation argument used by the Federal Reserve to endorse its three rate cuts in the dot plot almost untenable. With markets (outside of equities) largely casting a vote of no confidence in Powells dovish turn, 1y1y rates have jumped +45 basis points over the past few sessions, with the likelihood of a June rate cut plummeting to ~22%, USD It rebounded against most currencies.
Fortunately for the risk market, yesterdays PPI data was relatively mild. After rising by 0.6% and 0.3% respectively in February, both overall and core PPI rose by 0.2% month-on-month in March. However, although the overall annual growth rate has increased since It was a sharp decline from 11.7% in March 2022, but the annual growth rate of 2.1% in March compared with 1.6% in February is still moving in the wrong direction, posing some challenges to the narrative of slowing inflation.
Citi and Cleveland estimate that based on CPI/PPI elements, the Feds preferred core PCE indicator will increase by 0.26% month-on-month in March, similar to the growth rate in February. Due to the base effect and index composition, the annual growth rate is still expected to increase from 2.8 % fell to 2.7%, core services excluding housing are expected to increase by 0.29% month-on-month, while super core CPI is expected to maintain a month-on-month growth of 0.65%.
As expected, Fed officials were busy walking back previous comments about slowing inflation, with the Boston Feds Collins saying it may take more time than expected and saying first-quarter CPI was higher than I expected.
Richmond Feds Barkin said he expected to see more signs of a broader slowdown in inflation, not just goods inflation, after first-quarter super core services inflation came in sharply above expectations. Finally, New York Fed Williams in a QA A rate cut does not appear to be imminent, he said, suggesting there are certainly scenarios where we need higher rates, but thats not what I think is the base case.
The probability of an interest rate cut in June has dropped to 22.5%, and the pricing reflects expectations of less than two interest rate cuts throughout the year. Additionally, things get trickier given the timing of Fed meetings throughout the rest of the year.
June: Rate cut less likely
July: No summary of economic forecasts will be released (less important meeting, likely to keep the same pace as June)
September: Last meeting before elections
November: Days after the US election
As we can see, if the Fed skips a rate cut in June (currently only a 22% chance of a rate cut), they are unlikely to cut rates in July (a 32% chance) as no economic forecasts will be released at the July meeting Summary, usually of low importance unless the data moves significantly in a favorable direction within a month. The next meeting will be held in September, when the U.S. presidential election is in full swing. The Fed will face tremendous political pressure and cannot take overly biased actions against any candidate. In addition, compared with the second half of 2023, the base effect in the second half of this year is less friendly, and inflation may face greater challenges. The last remaining thing is the November meeting, which will be held a few days after the election. Imagine if the Fed stayed put all year, but decided to cut interest rates two days after the election (which Trump probably won), the media and conspiracy theorists How the discussion will proceed, there is no doubt that the Fed has been caught in a dilemma.
The bond markets stance is also fierce, with the 2-year yield quickly approaching 5% and the 10-year yield exceeding 4.50%. Wednesdays 10-year government bond auction was very bad, with a tail of 3.1 basis points and a bid-to-bid ratio of only 2.34 x, the subscription ratio for direct tenders also reached its lowest level in 2.5 years at just 14.2%, while the proportion for dealers was much larger.
Yesterdays 30-year auction improved slightly, but still performed poorly, with a tail of 1 basis point. Bid multiples and direct bidding participation were both weak. Dealers were allocated 17%, higher than the average 14%.
Bonds have been down overwhelmingly year-to-date, with the RSI indicator starting to move into oversold (price) territory, but given stubbornly high inflation coupled with a troubled Fed, its understandable that investors are less optimistic about duration exposure.
Despite the bleak outlook, there is one asset class that always takes it in stride and keeps coming back. Although the stock market was initially disappointed by expectations of a rate cut, attention quickly returned to good news is good news and stock prices recovered almost all of their losses after the data was released.
The SPXs outperformance, which has outperformed nearly every asset class (except perhaps cryptocurrencies), has left its implied yield relative to Treasuries at its lowest levels in almost 20 years, but that hasnt stopped equity investors from piling into well-performing stocks, for now There is also no sign of systemic risk.
A similar phenomenon has occurred in corporate bonds. The markets expectations for slowing down quantitative tightening (slowing down the balance sheet) have brought more buying of corporate bonds, thus keeping high investment grade bond spreads at historical lows.
On the important question of when interest rates will have an impact on stocks, Citi has conducted an analysis. They looked at the previous hawkish scenario and concluded that we are still some way away from the current interest rate changes having a negative impact on stocks. (~40-50 basis points). Investors also view this scenario as highly unlikely. They are convinced that the Fed will maintain a dovish bias amid strong growth and inflation, so it is impossible to imagine that they will completely rule out all implicit interest rate cuts. Therefore, investors choose to continue to focus on corporate earnings. Earnings (imminent), economic growth (strong), and friendly comments from the Fed support continued higher sentiment in the stock market. As it stands, an actual rate cut would be nothing more than an additional positive, as long as the current economic trajectory remains unchanged.
On the cryptocurrency side, BTC prices have been hovering around 70,000, with some bulls hedging and taking profits as major currencies failed to break through significantly. With the halving approaching, ETF inflows have slowed and market sentiment has been subdued, with more consolidation expected to follow.
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