Heightened market volatility settling in

02-13-2024
Heightened market volatility settling in

Markets react to the Fed’s recent bashfulness on rate cuts

 

It’s been a busy time for market watchers these past couple of weeks, featuring revised economic growth forecasts, regional bank surprises, some cold water from the Federal Reserve regarding a potential March rate cut, and a hot U.S. jobs report, among other headlines. Following are my key takeaways, and why they matter.

Economic growth forecasts largely improve for 2024

The International Monetary Fund (IMF) released its updated World Economic Outlook with some tweaks to the forecasts it released in October.1

Global. Its 2024 global growth forecast was upwardly revised to 3.1% from 2.9%, largely because of a more resilient U.S. economy and policy stimulus in China. The IMF acknowledged a reduced likelihood of a hard landing and noted the potential for faster disinflation.

United States. U.S. growth for 2024 was upwardly revised to 2.1% from 1.5%. This would still be a slowing of growth from 2023, which we expected as the impact of past rate hikes continues to weigh down the economy.

Euro area and United Kingdom. Euro area growth for 2024 was downwardly revised to 0.9% from 1.2%, but that would still be an improvement from an estimated 0.5% growth in 2023. The IMF expects the U.K.’s growth in 2024 to be even more modest, at 0.6%.

Japan. Japan’s growth for 2024 was also downwardly adjusted from 1.0% to 0.9%, which is well below Japan’s estimated 2023 growth of 1.9% but still above potential.

Emerging markets. Emerging markets were revised upward from 4% to 4.1%. An area of particular interest is emerging and developing Asia, where growth for 2024 was upwardly revised to 5.2% from 4.8%. This can be attributed to an improved outlook for China. Its 2024 growth was upwardly revised from 4.2% to 4.6%, reflecting “carryover” from better-than-expected growth in 2023 and increased government spending.

U.S. regional bank concerns surprised investors

Last week, New York Community Bank surprised markets in its earnings report by slashing its dividend as a result of some troubled commercial real estate loans and the need to increase its reserves. Markets were rattled by the news, which caused fears that the regional bank mini-crisis of last year might not be over, sending the KBW Regional Bank Index down more than 7% last week.2

However, it appears that this problem is largely contained rather than contagious. NY Community Bank is rather unique in its high level of exposure to commercial real estate loans and its low commercial real estate reserve ratio. It’s also important to note that the credit facility created last year, which was a critical factor in stabilizing the regional bank mini-crisis, is still in place and available for banks to utilize if needed.

The Federal Reserve tempers expectations for a March rate cut

The Federal Open Market Committee (FOMC) met last week and decided to hold its benchmark funds rate unchanged at 5.25% to 5.50% – its fourth consecutive pause. Markets were primed to hear about a potential March rate cut thanks to good inflation data and the news about New York Community Bank’s problems, but they came away disappointed because Federal Reserve Board Chair Jay Powell threw cold water on the notion that the Fed would start cutting in March.

However, I viewed the press conference positively. As I wrote recently, it’s OK if the Fed does not cut in March – there isn’t a big difference between March 20 and May 1. And it’s not about when the rate cuts start but how much is cut in 2024, and I expect it be higher than what the Fed anticipated in December.

I think it’s also important to note that Powell acknowledged a shift in the Fed’s thinking. A year ago, the Fed thought a softening of U.S. economic data was required for inflation to adequately ease. But now the Fed is comfortable with the strength of the U.S. economy, and it doesn’t believe the economy needs to weaken to see inflation be tamed. A few other takeaways:

  • Powell did admit that if the labor market unexpectedly weakens, that would speed up the start of rate cuts. But he maintained a hawkish tone, noting that more persistent inflation would move the timeline for cuts in the other direction.
  • The Fed’s balance sheet run-off so far has been going very well, Powell said, and he plans to begin in-depth discussions of the balance sheet in March.
  • Powell added that the Fed could cut rates and make alterations to balance sheet run-off at the same meeting. He sees them as separate tools, which is good to hear. The more flexibility the Fed has, the better.

As a follow-up to the Fed meeting, Powell was interviewed on the TV show “60 Minutes” where he reiterated and expanded on his remarks at the FOMC press conference. Powell again stated the unlikeliness of a March rate cut, explaining that he doesn’t need better data – he just needs more data: “It’s not that the data aren’t good enough. It’s that there’s really six months of data. We just want to see more good data along those lines. It doesn’t need to be better than what we’ve seen, or even as good. It just needs to be good. And so, we do expect to see that.”3

U.S. jobs jumped in January

The U.S. Employment Situation Report was, simply put, red hot. A whopping 353,000 non-farm payroll jobs were created in January, which was dramatically higher than consensus expectations.4 In addition, December non-farm payrolls were revised upward from 216,000 to 333,000. The unemployment rate was unchanged at 3.7%.

My focus is on average hourly earnings and the impact they could have on inflation. I must admit, January’s figures were too high for my taste, rising 0.6% month-over-month and 4.5% year-over-year.4 I’m optimistic that this is an anomaly, perhaps driven by a surprisingly shorter average workweek. I anticipate we will see tamer earnings growth in future jobs reports, more in line with the Employment Cost Index released last week, which showed more modest overall compensation growth.

Bond markets ride a roller coaster

Bond yields went on a wild ride in the last week of Januarey. Early in the week, the U.S. Treasury positively surprised markets, reducing its estimate for Treasury issuance for the current quarter – it now expects net borrowing of $760 billion for January through March, down from a previous estimate of more than $800 billion.5 With supply expected to be lower, bonds rallied. The 10-year U.S. Treasury yield fell to 3.86% on Thursday, only to rebound above 4% on Friday on the hotter-than-expected jobs report.6

Finally, we continue to see stocks impacted by bond yields. I would expect to see more of the same with heightened stock volatility driven by heightened bond volatility, which in turn is being driven by some uncertainty around Fed policy.

Kristina Hooper is Chief Global Market Strategist at Invesco.

Notes

1. Source: Moderating Inflation and Steady Growth Open Path to Soft Landing, World Economic Outlook Update, Jan. 2024.
2. Source: Bloomberg, as of Feb. 2, 2024.
3. Source: Jerome Powell: Full 2024 “60 Minutes” interview transcript, CBS News, Feb. 4, 2024.
4. Source: US Bureau of Labor Statistics, Feb. 2, 2024.
5. Source: Treasury Announces Marketable Borrowing Estimates, US Department of the Treasury, Jan. 29, 2024.
6. Source: Bloomberg, as of Feb. 2, 2024.

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