Ahead of FOMC, investors ride the hi-tech AI sugar rush


Asian markets are poised to open on Monday with a sense of optimism following Friday’s tech-driven rally on Wall Street. However, investors will be closely monitoring the latest developments in the remarkable and volatile decline of the Japanese yen against the US dollar and other major currencies.

On Friday, the yen reached a new 34-year low of 158.40 per dollar, continuing its downward trajectory after the Bank of Japan’s decision to keep interest rates unchanged, in line with expectations. However, what was unexpected was the central bank’s lack of significant concern about the yen’s exchange rate, contributing to its continued decline.

Last week, global equity markets received a much-needed boost from strong corporate earnings, fueled by optimistic forecasts for Alphabet (GOOG, GOOGL) and Microsoft (MSFT) earnings, reigniting hopes for a sustained rally led by Big Tech and providing some much-needed relief amidst persistently high inflation readings.

Investors were also closely observing the recent release of the Fed’s preferred inflation metric, the March personal consumption expenditures price index. The “core” measure, which excludes food and energy costs, showed a 2.8% year-over-year increase, slightly exceeding expectations but in line with the previous annual uptick.

Despite the potential for a more alarming inflation report, the market response to the latest personal income and spending data remained relatively muted. It even suggested a resurrection of the idea that the recent uptick in inflation pressures could have been primarily driven by seasonal factors limited to January. It’s worth noting that the PCE data for February and March showed more favourable results than the CPI.

Still, the macro landscape, remains precarious, with each data release keeping investors on edge. We’re still far from the slow, predictable disinflation scenario the Fed believes would warrant considering rate cuts.

Besides the stock markets living vicariously on a high-tech earnings sugar rush, this recent hawkish turn of events doesn’t bode well for the economic landscape. The combination of rising interest rates, postponed Fed rate cuts, and relentless inflation trends threatens to dampen consumers’ willingness and ability to spend.

Real consumer spending remained robust in March, but real disposable personal income growth has slowed markedly over the past year, while the personal savings rate has dropped to 3.2%, its lowest level since late 2022. The surge in nominal and real interest rates is likely to further weigh on consumer and business spending, including the housing market, in the coming quarters.

The latest Fed Beige Book highlighted weak consumer discretionary spending and increasing price sensitivity among consumers

Moreover, more U.S. borrowers are struggling to keep up with credit card and motor vehicle payments as higher interest rates and inflation take their toll. Data from the New York Fed shows that the 30-day delinquency on car and credit card debt hit their highest levels since the 2007 recession in the fourth quarter. The slower-than-expected real consumer spending growth in the first quarter could be the start of a series of sluggish quarters ahead until inflation eases and the Fed adjusts its monetary stance.

FOMC on tap

Previously, bullish sentiment was buoyed by the anticipation of multiple rate cuts, seen as a catalyst for sustained market growth. However, the narrative has shifted as market pricing reflects a more restrained approach ahead of the FOMC meeting with fewer projected rate reductions than the current dot plot for the year.

In his final public remarks before the blackout period preceding the April 30-May 1 FOMC meeting, Fed Chair Jay Powell expressed concern about persistent inflation and resilient economic growth. Powell further emphasized that rate cuts would be on hold until the Fed gains greater confidence in inflation moving sustainably toward the 2 percent target. Hence, the market has virtually priced in a more hawkish Fed scenario; other than removing all cuts from the dot plot, it’s unlikely the Fed will hawkishly surprise the market. But in a worst-case scenario where the Fed pushes rate cuts out to 2025, this poses a critical question for equity bulls: Can they maintain confidence in the absence of easing measures this year?

Well possibly…

Despite persistent inflation concerns, equities have shown resilience, rallying even in the face of adverse economic indicators and higher bond yields, leaving both bears and most market professionals scratching their heads.

Assuming the FOMC maintains its easing bias, the timing of the easing trajectory likely matters less than the assurance that the Fed is prepared to implement rate cuts if economic growth stumbles. In the meantime, nominal growth continues to be robust, providing a foundation for strong earnings.

Ultimately, despite grappling with persistent inflation in 2024, the Federal Reserve undoubtedly perceives the risks to its mandate as more balanced compared to a year ago. Consequently, the Fed could be particularly inclined to prioritize fostering economic growth, especially given its position in the hiking cycle, possibly near its terminal phase.

In essence, this suggests that equities may not need to fret excessively about interest rates. The economy appears to be functioning well with rates at their current levels, and both households and corporations are managing adequately on aggregate, providing a lift to earnings. Therefore, despite hawkish signals and proximate rates market reactions, if the economy continues to thrive, the Fed would likely hesitate to implement rate hikes until circumstances necessitate otherwise. 

Forex markets

The USD has experienced a loss of momentum over the past week. ( outside of the Yen) Despite US yields reaching fresh year-to-date highs, the USD has struggled to sustain its upward trajectory against most G10 currencies. The 10-year US Treasury yield peaked at 4.74%, marking a substantial increase of approximately 56 basis points since the end of the previous month.

One contributing factor to this trend is undoubtedly the rise in European yields, driven by an improving cyclical outlook in Europe. Additionally, there’s a growing perception of central bank synchronization with the Federal Reserve, further influencing currency dynamics.

Last week ECB De Guindos suggested that ECB policy decisions may not be as independent of the Federal Reserve as previously thought. Encouragingly buoyant European business confidence surveys added to the synchronization theory.

Incidentally, that also fueled the USDJPY “ meltup” as cross Yen was bought in tandem with the rise in  European yields.

Oil markets

Crude oil prices have recently experienced a welcome easing, alleviating concerns for both central bankers and consumers. Speculation surrounding the possibility of benchmark West Texas Intermediate (WTI) breaching the US$100/bbl mark has subsided, at least for now. The risk of disruptions to Iranian production has diminished following Israel’s measured response to prior drone attacks. However, crude oil markets are expected to remain volatile due to uncertainty surrounding the pace of global oil demand growth, increasing non-OPEC+/U.S. production, potential supply disruptions in Russia and the Middle East, and, crucially, OPEC+’s future production strategy.

OPEC+’s concerted efforts to implement production cuts have largely supported oil prices over the past year. However, internal tensions within the cartel persist, leading to a significant portion of the cuts being voluntary. The sustainability of these cuts is questionable, particularly as certain members, notably the UAE, continue to exceed their quotas. This dynamic strains the cartel’s overall cohesion, with the unity of OPEC+ heavily reliant on Saudi Arabia’s willingness to bear the brunt of production adjustments.

Meanwhile, Saudi Arabia faces mounting fiscal pressures, reflected in the International Monetary Fund’s (IMF) projection of the country’s fiscal breakeven crude oil price reaching US$96/bbl in 2024. Although the IMF anticipates a decline in breakeven prices by 2025, this is contingent upon the rollback of production cuts. It’s worth noting that these projections do not necessarily align with Riyadh’s actual price targets but provide insight into the level of crude oil prices needed to mitigate budget deficits.

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