Tag: us interest rates

Weekly Recap:

Stocks were mixed and bonds were lower last week, as somewhat hawkish comments from regional Fed presidents (and FOMC members) Raphael Bostic and James Bullard outweighed a clear weakening in incoming economic data.

Starting with the economy, most forward-looking metrics deteriorated last week. After a sharp rebound in activity in February, housing starts and new residential building permits fell sequentially in March, calling into question whether the nascent housing recovery is sustainable. Initial jobless claims continued to drift higher, extending the trend that began in March. And finally, the Conference Board’s Leading Economic Index (LEI) fell sequentially for the 12th month in a row, to a level that historically has been consistent with the onset of recession within a few months.

However, unlike earlier periods this year when a softening economy was met with optimism that the Fed may soon pivot to rate cuts, the comments from Bostic and Bullard served as a reminder that the Fed is firmly committed to the inflation fight. In response, Fed Fund Futures lowered the odds of any rate cuts happening in the back half of the year and yields rose across the Treasury curve, pushing bond prices lower.

The impact on equity prices was mixed as there was a discernable rotation across styles and sectors. Longer-dated growth stocks underperformed, causing the Nasdaq to lag the Dow and S&P. Defensives (staples, real estate, and utilities) held up better, to the benefit of small and midcap benchmarks with greater exposure to those sectors.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy enjoyed a strong second half of 2022, but corporate operating margins have been gradually falling as labor and input cost pressures bite. Albion’s base case expectation is that the US economy will enter recession in 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 18x is above the long run average. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the single digits.

Interest Rates

Rates rose in 2022 in response to a sharp pivot in monetary policy, but have mostly fallen (except for the very front end) so far in 2023. Futures markets are currently pricing in one additional 25bp rate hike in May, followed by a pause with the possibility of rate cuts in the back half of the year.

Inflation

After reaching 40yr highs in spring of 2022, inflation moderated in the second half of the year. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.

Weekly Recap:

It was a strong week for equities after inflation data for March came in slightly below expectations, although rates markets did not share in the enthusiasm after fresh survey data revealed that consumers’ near-term inflation expectations are rising.

Fresh inflation data was abundant last week. First, headline CPI was +0.1% m/m in March and fell to +5.0% y/y, while core CPI was +0.4% m/m and increased slightly to +5.6% y/y. Meanwhile, headline PPI was -0.5% m/m and fell to +2.7% y/y, the first time aggregate input price inflation has been below 3% since early 2021. Finally, import (-0.6% m/m) and export (-0.3% m/m) prices both fell sequentially.

Despite these clear disinflationary (or in some cases outright deflationary) trends, the University of Michigan’s monthly consumer sentiment survey showed a sharp uptick in 1-year forward inflation expectations, jumping from a final print of +3.6% in March to a preliminary April reading of +4.6%.

Knowing that the Fed has heightened sensitivity to inflation expectations, bond investors responded to the U of M survey by pushing yields higher across the curve on Friday, resulting in price declines for most high quality fixed income.

Equities also gave back some of their WTD gains on Friday after the U of M survey release, but key US benchmarks still managed to finish in the green for the week. Somewhat surprisingly, cyclicals were the biggest winners, despite the mid-week release of FOMC minutes containing a staff economic outlook that included a mild recession later this year.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy enjoyed a strong second half of 2022, but corporate operating margins have been gradually falling as labor and input cost pressures bite. Albion’s base case expectation is that the US economy will enter recession in 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 18x is above the long run average. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the single digits.

Interest Rates

Rates rose in 2022 in response to a sharp pivot in monetary policy, but have mostly fallen (except for the very front end) so far in 2023. Futures markets are currently pricing in one additional 25bp rate hike in May, followed by a pause and then multiple rate cuts in the back half of the year.

Inflation

After reaching 40yr highs in spring of 2022, inflation moderated in the second half of the year. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.

Weekly Recap:

Market remained on edge last week as investors digested the unfolding drama in the financial sector. The week began with several announcements aimed at staving off contagion from Silicon Valley Bank and Signature Bank. By Tuesday, however, it was clear that Credit Suisse, the giant Swiss bank with more than $500 billion in assets, was also facing a crisis of confidence amongst clients and counterparties and would not survive intact. Swiss officials raced to find a solution, but the sheer size of the institution meant there was really only one viable option – a shotgun marriage with longtime rival UBS, which was finally arranged on Sunday the 19th.

Domestic equity markets were mixed, with noncyclical large caps posting modest gains. Most cyclicals (financials, energy, materials, and industrials) and small caps were lower, as investors priced in a higher chance of a US recession.

Bond markets rallied for the second week in a row, as yields fell on safe haven demand. High yield corporates were the exception thanks to rapidly widening credit spreads, consistent with an increase in perceived recession risk.

Economic data was mixed last week. Core CPI (+0.5% m/m) came in slightly higher than expected, but Core PPI was flat m/m in a sign that upstream price pressures continue to moderate. Housing showed renewed signs of activity, with residential building permits (1.52mn) and housing starts (1.45mn) both rising sharply m/m. Initial jobless claims fell back below 200k in a clear sign of labor market strength. However, the Conference Board’s Leading Economic Index (LEI) fell sequentially for the 11th month in a row, and several gauges of manufacturing activity (Philly Fed, New York Fed, and Empire Manufacturing) remain in contraction territory.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy enjoyed a strong second half of 2022, but corporate operating margins have been gradually falling as labor and input cost pressures bite. Albion’s base case expectation is that the US economy will enter recession in 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 17x is above the long run average. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the single digits. The equity risk premium has expanded slightly over the past two weeks on concerns regarding the financial system.

Interest Rates

Rates rose across the curve in 2022 in response to a dramatic pivot in monetary policy. Fed Fund Futures are pricing in one more 25bp hike in March, followed by a pause and then several rate cuts in the back half of the year.

Inflation

After reaching 40yr highs in spring of 2022, inflation moderated in the second half of the year. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged. Real-time inflation data ticked higher sequentially in February of 2023.

Weekly Recap:

Last week was calm at the start, with rates relatively stable through Wednesday’s close while equities were only slightly lower. That all changed on Thursday, however, as market participants watched the rapid descent of Silicon Valley Bank into receivership. In the span of barely 24 hours, investors went from worrying about inflation and Fed policy to wondering how many small technology firms might suddenly have liquidity challenges and grappling with the possibility of a wider crisis of confidence within the banking system.

Asset price changes were consistent with a broad-based increase in risk aversion:

• Treasuries rallied
• Credit spreads widened
• Commodities fell
• Equity prices moved lower

Predictably, financials were the worst performing sector, while defensives such as staples and utilities were less impacted. Small caps underperformed, as one might expect given their greater dependency on banks for liquidity and financing.

This episode has radically altered investor expectations regarding the forward path of Fed policy, under the assumption that the Fed is less likely to further tighten policy if the banking system appears wobbly. One week ago, futures markets were pricing in 3 or 4 additional rate hikes in 2023, and no rate cuts prior to year-end. Futures now suggest that the Fed will hike 25bp in March and then stop, and that as many as three rate cuts could occur by December. As a result, the implied year-end Fed Funds rate has fallen nearly 150bp, from 5.56% to 4.10%, in just three days.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy enjoyed a strong second half of 2022, but corporate operating margins have been gradually falling as labor and input cost pressures bite. Albion’s base case expectation is that the US economy will enter recession in 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 18x is above the long run average. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the single digits. Most or all of 2022’s P/E multiple compression was driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates rose across the curve in 2022 in response to a dramatic pivot in monetary policy. Fed Fund Futures are pricing in one more 25bp hike in March, followed by a pause and then several rate cuts in the back half of the year.

Inflation

After reaching 40yr highs in spring of 2022, inflation moderated in the second half of the year. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged. Real-time inflation data ticked higher sequentially in February.

Weekly Recap

The holiday-shortened week was a tough one for financial markets thanks to recent trends in inflation, which does not appear to be cooling as quickly as market participants had hoped. The January print of US PCE (personal consumption expenditures, the Fed’s preferred inflation gauge), was higher than expected and showed sequential increases across the board:

• Headline PCE Deflator: +0.6% m/m, +5.4% y/y
• Core PCE Deflator: +0.4% m/m, +4.7% y/y

In response, rates continued to rise across the curve, particularly in the front end as the yield curve inversion deepened. Futures markets are now pricing in 25bp rate hikes at each of the next three FOMC meetings (March, May, and June), with very low odds of any rate cuts happening before the end of the year. Rising rates in February have erased most of the gains enjoyed by bond investors during January, leaving fixed income close to flat on the year.

Equities were not spared the selling pressure either. The S&P 500 was down for the 3rd week in a row, while the more rate-sensitive Nasdaq underperformed on weakness in longer-duration technology stocks.

Other economic data released last week showed a resilient US economy. Initial jobless claims remain below 200k/week, S&P Global’s Composite PMI rebounded into expansion territory (as did several regional Fed surveys), new home sales rose for the 2nd straight month, and the University of Michigan’s consumer sentiment index rose slightly in the final February print, with a notable gain in the future expectations component.

Albion’s “Four Pillars”

Economy & Earnings

The US economy enjoyed a strong second half of 2022, but corporate operating margins have been gradually falling as labor and input cost pressures bite. Albion’s base case expectation is that the US economy will enter recession in 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 18x is above the long run average. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the single digits. Most or all of 2022’s P/E multiple compression was driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates rose across the curve in 2022 in response to a dramatic pivot in monetary policy. Fed Fund Futures are pricing in a total of four 25bp hikes in 2023, with a “terminal” Fed Funds policy rate slightly above 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation moderated in the second half of the year. Headline inflation eased over the summer on falling energy prices, and core inflation followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is one factor keeping reported services inflation elevated, at least for now.