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The dizzying US economic data released this week has thrown the market into turmoil, but it's still just outside the danger zone.
Official figures on Thursday revealed that the US economy is not outperforming other developed countries as necessarily thought. It turned out that the growth rate in the first quarter was at an annualized pace of 1.6%, which was significantly lower than the 3.4% in the fourth quarter of last year and far different from the 2.5% that economists had expected. was.
In response, benchmark government bond prices soared, albeit briefly. This is a typical response to a severe shock to growth.
But other data, particularly on inflation, blurred the picture. On Friday, the Federal Reserve's most reliable gauge of price changes, the personal consumption expenditures data, showed a modest 2.7% increase in the year to March, well above expectations and also above previous month's readings.
Resistance groups that have been expecting the Fed to cut rates aggressively and soon in recent months have taken comfort from the relatively subdued PCE inflation data, adding to the bullish indicators from other indicators. I've been trying to ignore it. Numbers like Friday's are a clear indication that things are not headed in that direction. “No matter how you crunch the numbers, this is clearly not the kind of inflationary momentum that the Fed feels comfortable cutting rates,” said Jim Reed of Deutsche Bank.
As a result, bond prices have fallen again, with the benchmark 10-year bond yield back to just under 4.7% in November, as if the frenzy over expected rate cuts in late 2023 and into 2023 has completely subsided. It seems like it is. The beginning of this year was all a strange dream. Let's never talk about it again.
The big winners here are macro hedge funds betting that the Fed will cut interest rates this year and that bond yields will rise sharply as a result. I think we're all happy to see downtrodden billionaires enjoying their good fortune.
For the rest of us humble humans, the persistent combination of slowing growth and inflation is worrying.
The bond market is already feeling the death of the rate cut trade badly. “Bonds are no joke,” said Michael Kelly, global head of multi-asset at PineBridge Investments. “It's an earthquake.”
On the other hand, as long as rising interest rates are the result of a strong economy, and as long as investors are confident that the next rate move will be a rate cut, stocks can handle the situation well, he said. “I really don't think the stock market will fall out of bed as long as the outlook is down rather than up,” he said.
But given the latest data, it's a little hard to be sure on either of these fronts, so Thursday's strong decline in stocks was only saved by upbeat earnings from Alphabet and Microsoft.
A rise in U.S. interest rates this year remains a distant prospect. But some investors are still starting to take the prospect more seriously. “That's a real problem for the stock market,” to say the least, said Robert Alster, chief investment officer at Close Brothers Asset Management.
The mood in the market is somewhat bearish right now, especially as the persistent nature of inflation has caught even the wisest economists by surprise. However, unlike last fall, when the view that interest rates would remain high for a long time was firmly established, things have calmed down now. Some investors are even relishing the chance to buy more stocks after the recent rare price drop. The number 5 is the key that can bring about this change.
Round numbers shouldn't matter in the market, but in reality they do, and the closer the benchmark 10-year Treasury yield approaches 5%, the louder the noise will be.
Thinking back to October, we approached that point and when we got to that point, there was a moment of panic over a really big issue. Who will buy all the U.S. government bonds? How will the world's greatest superpower raise the money? Will the dollar continue to be the world's major reserve currency?
As always, the answers to these questions are: 1: Low prices for everyone. See 2:1. And 3: Yes. But when these discussions take place, it's never a comfortable experience.
The current bond yield reset is different from last year. Inflation is higher than desired, but significantly lower. But as yields reach such noteworthy high levels, the question becomes clearer: Is it really worth buying stocks when you can earn such returns on risk-free bonds? Masu. At the same time, money bugs and financial crisis enthusiasts emerge, putting a damper on widespread enthusiasm for risk assets.
Investing is not as simple as “selling all the big numbers.” But when your mood is unstable, these mind games can have a big impact.
“Five is a really good number,” said Mr Alster of Close Brothers. “As long as we're under five and the inflation statistics aren't getting worse…I think we can convince ourselves that the next move is going down and we'll be fine.”
katie.martin@ft.com
