by John Lynch, CIO, & Team, Comerica Wealth Management
The Federal Reserve meets this week with recent inflationary headwinds. Market interest rates have nudged higher and equity indexes appear to be running into resistance.
Executive Summary
Recent pricing data was stronger than expected, likely extending the Fed’s “higher for longer” stance.
- While all the focus has been on stock market records, the U.S. Treasury Yield Curve also celebrated a milestone this past week. At 425 trading days and counting, the yield curve has been inverted for the longest period in its ~50-year history.
- The U.S. 10-year Treasury yield is now hovering at the upper end of the range (3.80% to 4.30%) it has occupied over the past six months.
- The strong rally off the October lows is running into resistance of late, with the S&P 500® Index finishing down for the second consecutive week.
While a pause is plausible in the equity markets, it would be consistent with seasonal weakness typical in presidential election years and is something to be prepared for as investors can use weakness to rebalance portfolios back toward targeted longer-term allocations.
Inflation and the Fed
Recent pricing data was stronger than expected, likely extending the Fed’s “higher for longer” stance.
Indeed, the Consumer Price Index (CPI) print topped estimates in February for the second consecutive month, as reduced shelter prices were offset by increases in the costs for used cars, clothing and air travel. The core CPI, which excludes volatile food and energy prices, increased 0.4% in February and is now up 3.8% year-over-year (YOY). It should be noted that Core CPI has been trending higher recently, increasing at an annualized rate of 4.2% over the last three months, the fastest pace since June. See chart: CPI and Core CPI - YOY.
Wholesale prices also came in above expectations last month, as the Producers Price Index (PPI) climbed 0.6% from January’s level and coming in twice the consensus estimate of 0.3%.
The latest pricing data provides further evidence of stalling disinflation, giving monetary policymakers more reasons to hold off on cutting interest rates. Investors will look for some clarity from Fed Chair Jerome Powell at this week’s FOMC meeting relative to the timing and magnitude of policy easing.
We continue to look for three rate cuts, beginning in June, which should also coincide with the Fed’s plans to begin moderating the pace at which maturing Treasury and mortgage securities roll off its balance sheet (quantitative tightening).
Fed Funds Futures markets responded by further slashing the number of cuts priced-in this year. The implied Fed Funds rate for the end of the year sits above 4.5%, the highest it has been since November. This suggests consensus expectations have declined from six cuts in 2024 to a range of three-four cuts, instead.
U.S. Treasury Yield Curve
While all the focus has been on stock market records, the U.S. Treasury Yield Curve also celebrated a milestone this past week. See chart: U.S. Treasury Yield Curve.
At 425 trading days and counting, the yield curve has been inverted for the longest period in its ~50-year history. Moreover, the spread between the 2-year Treasury bill and the 10-year Treasury note has accomplished this feat without triggering recession. Typically, it stands to reason that if financing costs over the near term are greater than those over the longer term, enough activity would be delayed resulting in negative output growth.
However, this cycle is not typical. Employment has remained solid and the money supply, as defined by M2, is up ~30.0% to $20.5 trillion since the fourth quarter of 2019, providing ballast to consumers and businesses, many of whom were desensitized to tighter Fed policy, having secured long-term funding at lower rates over the prior several years.
In addition, the U.S. 10-year Treasury yield is now hovering at the upper end of the range (3.80% to 4.30%) it has occupied over the past six months or so. It should be noted that this trend contrasts with global yields, which are decidedly lower. A break higher in the U.S. benchmark may provide pressure to the recent strength in both the economy and stock prices.
Equities
The strong rally off the October lows is running into resistance of late, with the S&P 500® Index finishing down for the second consecutive week. See chart: S&P 500® Index.
Of course, a better than expected fourth quarter earnings season is wrapping up and investors are searching for another catalyst for the next move higher. Inflation pressures persist and market interest rates have nudged higher as consensus expectations for the next Fed rate cut keep getting pushed out.
We have been pleased that participation in the equity market has broadened out, with the equally weighted S&P 500® beginning to catch up with its more popular cap-weighted Index, though it still trails by approximately 300 basis points year-to-date.
As several names in the Magnificent Seven struggle, the S&P 500® Index is exhibiting signs of a near-term top as momentum begins to moderate. Indeed, negative divergences are evident with the Index hovering near its highs while momentum, as measured by the 14-day Relative Strength Index (RSI), has broken lower. A break below the February 5,050 level could bring the 50-DMA of ~4,950 into play, followed by the December 2021 – January 2022 high of 4,820. Considering good earnings prospects, copper’s recent breakout, declining global yields, a U.S. dollar that appears to have topped, and full employment, we suspect any pullback would be in the -5.0% to -6.0% range.
While a pause is plausible in the equity markets, it would be consistent with seasonal weakness typical in presidential election years and is something to be prepared for as investors can use weakness to rebalance portfolios back toward targeted longer-term allocations.
Be well and stay safe!
Contributors
John Lynch
Chief Investment Officer
Comerica Wealth Management
Deborah Koplik
Director Portfolio Management
Comerica Wealth Management
Matthew Anderson
Senior Analyst
Comerica Wealth Management
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