Rate Cut Hopes Dim Amid Strong US Data

For the week ending 2 February 2023

As of midday Friday, global equities were higher on the week amid solid earnings reports from several megacap tech companies. The yield on the US 10-year Treasury note fell 0.15% to 4% but looks set to end the week well above its lowest levels after concerns over the health of US regional banks reemerged at midweek, contributing to a drop in yields to as low as 3.82% on Thursday. The price of a barrel of West Texas Intermediate crude oil slumped more than $5 to $72.10. Volatility, as measured by the Cboe Volatility Index (VIX), was steady at 13.9.

MACRO NEWS

US payrolls continue to swell

Nonfarm payrolls in the United States rose 353,000, doubling estimates, while revisions to the prior two months added 126,000 jobs to the January tally and annual revisions added 359,000 jobs to the 2023 total. The month-over-month reading for average hourly earnings also doubled expectations, rising 0.6% from the month before while gaining 4.5% from a year ago. However, hours worked declined to the lowest levels since the start of the pandemic in March 2020. The unemployment rate held steady at 3.7%. These data, along with a bounceback in the manufacturing sector and stronger consumer confidence readings, have prompted investors to pare back bets that the US Federal Reserve will begin cutting rates over the next few meetings.  Odds of a 0.25% cut at the March meeting have fallen to 20% from 50% a week ago. The likelihood of a May cut has also fallen.

Fed drops tightening bias but signals no cut imminent

Fed Chair Jerome Powell said Wednesday that members of the Federal Open Market Committee want to feel more confident that inflation is on a sustainable path toward its 2% target before cutting interest rates. Powell took the unusual step of essentially ruling out a cut as early as March, prompting the market to shift expectations to a first reduction in May. The Fed chair said he sees a greater risk of inflation stabilizing meaningfully above the Fed’s target than of there being a reacceleration in price gains. The Fed will discuss shrinking its balance sheet at its March meeting, Powell said.

Bank CRE exposure back in spotlight

A sharp drop in the share price of New York Community Bancorp, after the company slashed its dividend and increased loan loss reserves, prompted a broad decline in US regional bank shares late this week as the sector’s exposure to the troubled commercial real estate sector burst back into the spotlight. CRE concerns were not limited to the United States, however, as two foreign banks, Japan’s Aozora Bank and Germany’s Deutsche Bank, each raised loan loss reserves due to US commercial real estate loans. Real estate analytics firm Trepp reports that banks face about $560 billion in commercial mortgage loan maturities by the end of 2025.

Lagarde keeps eye on wages

European Central Bank President Christine Lagarde said this week that the central bank’s governing council in unanimous in the view that its next move will be to cut rates, though she said more data is needed as “we’re not there yet” on inflation. Wage data will be particularly important in the ECB’s calculus, she said. It was reported this week that eurozone unemployment held steady at a record-low 6.4% in November.

QUICK HITS

The Washington Post reports that presumptive Republican US presidential nominee Donald Trump is considering levying 60% tariffs on imports from China if reelected. Trump also told Fox Business that he would not reappoint Jerome Powell to a third term as Fed chair when his current term expires in 2026.

Saudi Arabia has scrapped plans to expand the country’s oil production capacity to 13 million barrels a day from its current 12 million barrels over the coming years. At present, the kingdom is producing roughly nine million barrels a day and doesn’t see the need to increase medium-term capacity. Riyadh also announced that it is resuming defense talks with the United States that were paused at the outset of the Israel-Hamas War.

Unable to reach agreement with its creditors, Chinese property developer Evergrande was ordered to liquidate by a court in Hong Kong.

Chinese shares are off to a bad start in 2024, with the Shanghai composite losing 6.25% in January.

According to Bloomberg, US investment-grade corporate bond issuance hit a record $188 billion in January.

The Conference Board’s US consumer confidence index rose to 114.8 in January from 108 in December to its highest level since the end of 2021.

US President Joe Biden said this week that he holds Iran responsible for the deaths of three US service members after an attack on an outpost in Jordan by militias supplied by Iran. However, Biden said the US does not seek to widen the war in the Middle East.

China’s composite purchasing managers’ index rose to 50.9 in January from 50.3 in December, though the manufacturing sector continued to contract.

A divided Bank of England held rates steady this week; two policymakers voted for a hike while one voted to cut rates.

The Institute for Supply Management’s manufacturing index rose to 49.1 in January from 47.1 in December as the new orders component jumped to 52.2 from 47.

Economic growth in Canada ticked up in November, expanding at a 1.1% annual rate, faster than the 0.9% pace set in October.

The eurozone avoided a technical recession after Q4 gross domestic product rose 0.1%, offsetting a Q3 decline. 

EARNINGS NEWS

With just 45% of the constituents of the S&P 500 Index having reported for Q4 2023, blended earnings per share (which combines reported data with estimates for those that have yet to report) shows that earnings rose 1.5% compared with the same quarter a year ago, according to data from FactSet. Sales growth is up 3.4% year over year.