The Fed's situation has undoubtedly become more difficult.
The market is facing unfriendly inflation data, especially Wednesday's CPI. Core prices are moving in an undesirable direction. Both overall CPI and core CPI increased by 0.4% month-on-month in March, and 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 "inflation gradually slowing" 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 Powell's dovish turn, 1y 1y rates have jumped +45 basis points over the past few trading days, with odds of a June rate cut plummeting to ~22 %, the dollar rebounded against most currencies.
Fortunately for the risk market, yesterday's 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 been There 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 the Fed's preferred core PCE indicator, based on CPI/PPI elements, will increase by 0.26% month-on-month in March, similar to the growth rate in February. Due to base effects and index composition, the annual growth rate is still expected to decline from 2.8% to 2.7%. Core services excluding housing are expected to increase by 0.29% month-on-month, while the super core CPI is expected to remain at 0.65% month-on-month.
As expected, Fed officials were busy walking back previous comments about slowing inflation, with the Boston Fed's Collins saying it "may take more time than expected" and saying "first-quarter CPI was higher than I expected."
Richmond Fed's Barkin said he expected to see more "signs of a broader slowdown in inflation, not just goods inflation," after first-quarter supercore services inflation came in significantly higher than expected. Finally, New York Fed Williams in Q&A "A rate cut does not appear to be imminent," China said, suggesting "there are certainly scenarios where we need higher rates, but that's not what I think is the base case."
The probability of a rate cut in June has fallen to 22.5%, with pricing now reflecting less than 2 rate cuts for the full year. Moreover, given the timing of the Fed meetings for the rest of the year, things are becoming even trickier.
June: Low chance of rate cut
July: No Summary of Economic Projections (less important meeting, likely to follow the same cadence as June)
September: Last meeting before elections
November: Days after the US election
As we can see, if the Fed skips cutting rates 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, and the Fed will be under intense political pressure not to act too favorably against any candidate. In addition, inflation may face greater challenges due to a less friendly base effect in the second half of this year compared to the second half of 2023. 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 market also expressed itself more intensely, with the 2-year yield rapidly approaching 5% and the 10-year yield exceeding 4.50%. Wednesday's 10-year Treasury auction was very poor, with a tail of 3.1 basis points and a bid-to-cover ratio of only 2.34x. The subscription ratio of direct bids also reached the lowest level in 2.5 years at only 14.2%, while the proportion of dealers was much larger.
Yesterday’s 30-year auction was slightly better but still underperforming with a tail of 1 basis point, weak bid-to-cover ratios, weak direct bid participation, and dealer allocations of 17%, above the average of 14%.
Bonds have been falling year-to-date, with the RSI indicator beginning to enter oversold (price) territory, but given high inflation and a troubled Fed, it is understandable that investors are less optimistic about duration risk exposure.
Despite the gloomy outlook, there is one asset class that has always managed to take it in stride and keep making a comeback. While the stock market was initially disappointed with the expectations of rate cuts, attention quickly returned to “good news is good news” and stock prices recovered nearly all of the losses after the data was released.
The SPX’s outperformance, which has outperformed nearly every asset class (except perhaps cryptocurrencies), has put its implied yield relative to U.S. Treasuries at its lowest level in nearly 20 years, but that hasn’t stopped equity investors from piling into the well-performing names, and there are no signs of any systemic risk in sight.
A similar phenomenon has occurred in corporate bonds, where expectations of slower quantitative tightening (slower balance sheet reduction) have led to more buying of corporate bonds, keeping high investment grade bond spreads at historic lows.
On the important question of when interest rates will have an impact on stocks, Citigroup has done an analysis where they looked at previous “hawkish” scenarios and concluded that we are still some distance away (~40-50bps) from the current rate move having a negative impact on stocks. Investors also view this scenario as highly unlikely, and they are certain that the Fed will remain dovish amid strong growth and inflation, so it is unimaginable that they will completely rule out all implied rate cuts, so investors choose to continue to focus on corporate earnings (coming soon), economic growth (strong), and friendly comments from the Fed to support continued higher stock market sentiment. As it stands, an actual rate cut is nothing more than an additional tailwind as long as the current economic trajectory remains unchanged.
On the cryptocurrency front, BTC prices have been hovering around 70,000, with some bulls hedging and profit-taking as major currencies failed to break out significantly to the upside. With the halving approaching, ETF inflows have slowed and market sentiment has been subdued, with more consolidation expected to follow.
