S&P 500 Hit by Fed-Pivot Rethink and War Jitters: Markets Wrap

(Bloomberg) — Wall Street traders sent stocks and bonds sliding after another hot inflation report signaled the Federal Reserve will be in no rush to cut rates this year. Oil climbed as geopolitical jitters resurfaced.

Equities extended their April losses, with the S&P 500 down about 1% as the consumer price index beat forecasts for a third month. In a hawkish reprice of the Treasury curve, 10-year yields topped 4.5% and Fed swaps are now showing bets on only two rate cuts for 2024. A sharp reversal in oil also weighed on sentiment, with Bloomberg News reporting the US and its allies believe major missile or drone strikes by Iran or its proxies on Israel are imminent.

As the Fed rides the “last mile” toward its 2% inflation goal, the concern is that price pressures may not be just a “bump in the road” — with the higher-for-longer rate narrative taking hold. Minutes of the last Fed meeting showed “almost all” officials judged it would be appropriate to pivot “at some point” this year. But inflation since then has upended market bets.

“It’s often said that the Fed takes the escalator up and the elevator down when setting rates,” said Richard Flynn at Charles Schwab. “But for the path downwards in this cycle, it looks like they will opt for the stairs.”

The Fed minutes also showed policymakers “generally favored” slowing the pace at which they’re shrinking the asset portfolio by roughly half.

The S&P 500 dropped to around 5,160. US two-year yields surged 23 basis points to 4.97%. The dollar jumped the most since January. A weak $39 billion sale of 10-year bonds also boosted yields. Brent crude topped $90. The yen plunged through a level that Wall Street has warned could push Japan to step into the market.

The March core consumer price index, which excludes food and energy costs, increased 0.4% from February, according to government data out Wednesday. From a year ago, it advanced 3.8%, holding steady from the prior month.

These inflation figures — alongside the jobs report released last week — complicate the timing of the Fed’s rate cuts, according to Tiffany Wilding at Pacific Investment Management Co. 

Not only there’s now a strong case to push out the timing of the first reduction past mid-year, it also strengthens the odds that the US will ease policy at a more gradual rate than its developed-market counterparts, she noted.

“Inflation right now is like the ‘stubborn child’ that refuses to heed the parent’s call to leave the playground,” said Jason Pride at Glenmede. “As a result, investors should be prepared for a higher-for-longer monetary regime.”

That doesn’t mean rates are going higher — but the distance to a rate cut is another quarter, according to Jamie Cox at Harris Financial Group.

“You can kiss a June interest-rate cut goodbye,” said Greg McBride at Bankrate. “There is no improvement here, we’re moving in the wrong direction.”

To Neil Dutta at Renaissance Macro Research, Fed officials are still cutting this year — but they won’t be starting in June.

“I think July is probable, which means two cuts remain a reasonable baseline,” Dutta said. “If the Fed does not get a cut off in July, however, investors will need to worry about path dependency. As an example, would September be too close to the election? If not June, then July. If not July, then December.”

At the start of the year, the amount of easing priced in for 2024 exceeded 150 basis points. That expectation was based on the view that the US economy would slow in response to the Fed’s 11 rate hikes over the past two years. Rather, growth data has broadly exceeded expectations.

While Fed Chair Jerome Powell has repeatedly stressed that financial conditions are weighing on the economy, many market-based measures suggest otherwise. Stocks have added $12 trillion in value since October alone, contributing to readings in a gauge of financial conditions tracked by Bloomberg that are looser now than before the Fed began tightening.

“Easy financial conditions continue to provide a significant tailwind to growth and inflation. As a result, the Fed is not done fighting inflation and rates will stay higher for longer,” said Torsten Slok at Apollo Global Management. “We are sticking to our view that the Fed will not cut rates in 2024.”

Former Treasury Secretary Lawrence Summers went a step further to say that one would have to “take seriously the possibility that the next rate move will be upwards rather than downwards.” Such a likelihood is somewhere in the 15% to 25% range, he told Bloomberg Television’s Wall Street Week with David Westin.

Despite early evidence of a re-heating economy, the bar for Fed hikes at this stage is quite high, according to Lauren Goodwin at New York Life Investments.

“A signal that interest rates could move higher would likely be met with a rapid tightening in market financial conditions,” she noted. “We believe there is enough evidence of gradually expanding cracks in the economy to keep further tightening off the table unless inflation accelerates meaningfully.”

Another hot CPI reading may have been “the final nail in the coffin” for a June rate cut, but it remains to be seen whether 2024 will turn out to be a two-cut year, or something less, according to Chris Larkin at E*Trade from Morgan Stanley.

To Chris Zaccarelli at Independent Advisor Alliance, the Fed still has a bias to cut rates and is likely to do so in either July or September. Still, if inflation remains sticky, that may be the only rate cut we get this year.

“Goldilocks has left the building,” he added. “Inflation isn’t coming down anymore and rate-cut hopes are going to be pushed off even further into the future.”

Traders and policymakers alike risk reading too much into the hotter-than-expected US inflation print that jolted markets and called into question the central bank’s interest-rate cutting cycle, according to a top macro strategist at Citadel.

“It was never going to be a steady path. We’re seeing bumps, and the bumps are just part of the game,” Angel Ubide at Citadel told Bloomberg Television. “Unless there’s a policy mistake — and I’m not saying that there will be — we should see inflation converging gradually towards 2%,” he said.

Traders spooked by Wednesday’s hotter-than-expected inflation print need not to worry, according to Jefferies’ David Zervos — who says risk assets can thrive with or without interest rate cuts by the Fed.

US equities are likely to continue their uptrend based on good economic news, which Zervos, the bank’s chief market strategist, expects to swamp discussions about keeping rates higher for longer.

Another aspect to consider is that this year’s selloffs have been short-lived, given the equities benchmark’s torrid rally from its October low, which has been powered by Corporate America’s improving earnings outlooks and a resilient US economy.

For one thing, the S&P 500 has rebounded after each of the prior four days in 2024 when it sold off at least 1% — averaging a gain of roughly 1% the following session, according to data compiled by Bloomberg.

As the hot inflation print all but removed the possibility of rate cuts in the near future, that leaves earnings as a last leg of support for the resilient stock market rally that began last year.

“The reaction to the CPI report adds further fuel to the belief that equity markets are in for a period of sluggishness,” said Mark Hackett at Nationwide. “As the focus shifts to earnings season, investors may watch with a different lens, with strong results potentially further adjusting rate cut assumptions, returning us to a ‘good news is bad news’ posture.”

To Jose Torres at Interactive Brokers, risk assets are approaching a fork in the road. 

“If the Fed implicitly accepts price pressures between 3% and 4%, the inflation put has been born, providing another stabilizing force on top of the traditional Fed and dividend puts,” Torres said. “But if the central bank remains committed to 2%, hell or high water, then a meaningful equities correction will occur. This correction could be significant, with equity valuations expanding mainly due to expectations that the Fed will make significant rate cuts this year.”

Torres said that would would help sustain corporate earnings while reducing the likelihood of the economy entering a recession.

“We find ourselves in an environment where stocks appear fully valued, market interest rates are climbing and the consensus expectation for Federal Reserve rate cuts is dwindling,” said John Lynch at Comerica Wealth Management. “It is therefore imperative, in our opinion, that corporate profits continue to expand to justify current levels of equity valuation and investor sentiment.”

With banks slated to unofficially kick off first-quarter earnings this week, their results will be watched closely to see whether growth can justify an S&P 500 price-earnings ratio that’s roughly 20% above its 10-year average. At 21 times profits, that translates to an earnings yield of 4.8%, a multiple that looks increasingly unfavorable with 10-year Treasury yields rising to 4.5%.

Wall Street’s Reaction to CPI Data:

• David Kelly at JPMorgan Asset Management:

That’s the sound of the door slamming shut on a June rate cut.

• Quincy Krosby at LPL Financial:

The Fed’s last mile just got longer and bumpier. The Fed may still be able to cut in June, but the narrative is getting increasingly difficult. 

• Matthew Weller at Forex.com and City Index:

No matter how you slice the data, it’s hard to argue that inflation is falling. For a central bank that was looking for any sign that inflation was continuing to fall toward its target, this report will be a big disappointment for the Federal Reserve.

• Jeff Schulze at ClearBridge Investments:

This inflation release effectively takes June off the table for the first rate cut and should push the odds out further with a coin toss in July or September.

• John Leiper at Titan Asset Management:

This reinforces our view that the market remains too optimistic on rate cuts this year given the underlying strength of the US economy.

• Charles Hepworth at GAM Investments:

For the June rate cut optimists, this reading is a bit of blow. Markets have been wrestling with the likelihood of the Federal Reserve delivering on three rate cuts this year, but on these numbers, two rate cuts may now be the more likely outcome.

• Neil Birrell at Premier Miton Diversified Funds:

The US economy is running along at quite a pace and a June rate cut looks less and less likely – July or September is the call now. The Fed has got some head scratching to do and if other central banks were waiting for the Fed to move, they have got a conundrum on their hands now.

• Lindsay Rosner at Goldman Sachs Asset Management:

The rates market needs to seriously consider the likelihood of higher-for-longer at minimum lasting through the Summer and potentially through the end of the year. This number did not eclipse the Fed’s confidence, it did, however, cast a shadow on it.

• Seema Shah at Principal Asset Management:

This marks the third consecutive strong reading and means that the stalled disinflationary narrative can no longer be called a blip. In fact, even if inflation were to cool next month to a more comfortable reading, there is likely sufficient caution within the Fed now to mean that a July cut may also be a stretch.

Corporate Highlights:

• President Joe Biden reiterated his support for US workers opposed to a Japanese company’s bid to acquire United States Steel Corp., while stopping short of calling again for continued domestic ownership.
• Vertex Pharmaceuticals Inc. agreed to buy Alpine Immune Sciences Inc. for a total equity value of about $4.9 billion, adding the biotech company’s immune treatments in its biggest acquisition ever.
• Adobe Inc. has begun to procure videos to build its artificial intelligence text-to-video generator, trying to catch up to competitors after OpenAI demonstrated a similar technology.
• Meta Platforms Inc. is deploying a new homegrown chip to help power its artificial intelligence services, aiming to decrease its reliance on semiconductors from Nvidia Corp. and other outside companies.
• Delta Air Lines Inc. expects earnings to exceed Wall Street’s projections for the second quarter as the carrier benefits from a step-up in corporate travel and steady leisure demand heading into summer.
• Macy’s Inc. named two new directors nominated by activist investor Arkhouse Management Co., which agreed to end its effort to seek majority board representation as it attempts to acquire the department-store operator.
• Apple Inc. assembled $14 billion of iPhones in India last fiscal year, doubling production in a sign it’s accelerating a push to diversify beyond China.
• Taiwan Semiconductor Manufacturing Co.’s quarterly revenue grew at its fastest pace in more than a year, shoring up expectations that a global boom in AI development is fueling demand for high-end chips and servers.
• UBS Group AG faces a “substantial” increase in regulatory capital requirements under reforms that the Swiss government is advocating for in the wake of the collapse of Credit Suisse.

Key events this week:

• China PPI, CPI, Thursday
• Eurozone ECB rate decision, Thursday
• US initial jobless claims, PPI, Thursday
• New York Fed President John Williams speaks, Thursday
• Boston Fed President Susan Collins speaks, Thursday
• China trade, Friday
• US University of Michigan consumer sentiment, Friday
• Citigroup, JPMorgan and Wells Fargo due to report results, Friday.
• San Francisco Fed President Mary Daly speaks, Friday

Some of the main moves in markets:

Stocks

• The S&P 500 fell 0.9% as of 4 p.m. New York time
• The Nasdaq 100 fell 0.9%
• The Dow Jones Industrial Average fell 1.1%
• The MSCI World index fell 0.9%

Currencies

• The Bloomberg Dollar Spot Index rose 0.8%
• The euro fell 1.1% to $1.0743
• The British pound fell 1.1% to $1.2540
• The Japanese yen fell 0.8% to 152.95 per dollar

Cryptocurrencies

• Bitcoin rose 1.3% to $69,997.81
• Ether rose 0.3% to $3,521.72

Bonds

• The yield on 10-year Treasuries advanced 18 basis points to 4.55%
• Germany’s 10-year yield advanced six basis points to 2.44%
• Britain’s 10-year yield advanced 12 basis points to 4.15%

Commodities

• West Texas Intermediate crude rose 1.3% to $86.31 a barrel
• Spot gold fell 0.9% to $2,331.31 an ounce

This story was produced with the assistance of Bloomberg Automation.

–With assistance from Sagarika Jaisinghani, Alexandra Semenova, Carter Johnson, Felice Maranz, Liz Capo McCormick, Jessica Menton, Carly Wanna, Natalia Kniazhevich, Denitsa Tsekova, Lu Wang and Ryan Vlastelica.

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