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The upside-down U.S. economic data released this week left markets in a pickle, but still just outside the danger zone.
Official figures revealed Thursday that the U.S. economy is not necessarily ahead of the rest of the developed world as previously thought. It turns out that growth reached an annualized rate of 1.6 percent in the first quarter – well below the 3.4 percent in the fourth quarter of last year and far from the 2.5 percent expected by economists.
For a tiny moment, benchmark government bonds soared in response – a typical reaction to a sharp shock to growth.
But other data have muddied the picture, particularly on inflation. On Friday, the Federal Reserve’s main measure of price movements – personal consumption expenditures – showed a slight increase to 2.7 percent over the year through March, a nose above forecasts and at -above the previous month’s figure.
For months, holdouts hoping the Fed would cut interest rates aggressively, and soon, were reassured by the PCE’s relatively calm inflation data and sought to brush aside the bracing numbers from other measures. Numbers like Friday’s really highlight that the direction of movement is not going in that direction. “No matter how you look at the numbers, this is clearly not the kind of inflation dynamic where the Fed would feel comfortable cutting rates,” noted Deutsche Bank’s Jim Reid .
The result is that bond prices have fallen again and yields on benchmark 10-year bonds have returned to where we were in November, just below 4.7 percent, as if all the frenzy around expected rate cuts at the end of 2023 and at the beginning of this year was just a strange dream. Let’s never talk about it again.
The big winners here are macro hedge funds that have bet on few or no rate cuts from the Fed this year and a corresponding rise in bond yields. I’m sure we’re all excited to see the downtrodden billionaires enjoying a lucky break.
For the rest of us mere mortals, this combination of slower growth and nagging inflation is a troubling mix.
The bond markets have already taken the death of the rate cut badly. “Fixed income didn’t get the joke,” said Michael Kelly, global head of multi-asset at PineBridge Investments. “It’s an earthquake.”
Stocks, meanwhile, can take that situation with ease as long as rising interest rates are the result of a stronger economy, he said, and as long as investors are confident that the next hike rates, whatever it is, will be a decline. “I really don’t think the stock market is going to collapse as long as the predictions are down, not up,” he said.
But it’s a little harder to be certain on either front in light of the latest data, hence a pullback in stocks on Thursday that was only saved by upbeat results from Alphabet and Microsoft.
A rise in US interest rates this year remains a distant project. But it remains a prospect that some investors are starting to take more seriously. To say the least, “it would really be a problem for the stock market,” said Robert Alster, chief investment officer at Close Brothers Asset Management.
Right now, the market mood is somewhat pessimistic, especially since the sticky nature of inflation has caught even the most astute economists off-guard. But unlike last fall, when the idea that rates would be higher for longer really took hold, things are calm. Some investors even welcome the opportunity to load up on stocks after a rare recent price decline. The key to what could bring about this change is the number five.
Round numbers shouldn’t matter in the markets, but the reality is that they do, and the closer the 10-year Treasury yield gets to 5 percent, the louder the noise will become.
If you go back to October, the approach and then reaching of this point triggered a moment of panic around the very big questions. Who will buy all the US government bonds? How will the world’s leading superpower finance itself? Will the dollar remain the main global reserve currency?
As always, the answers to these questions were: 1: everyone, but at a lower price; 2: see 1; and 3: yes. But it is never a comfortable experience when these are the debates.
The current revision of bond yields is different from last year. Inflation, although higher than desired, is significantly lower. But when yields reach these kinds of notable highs, the question of whether it’s really worth buying stocks when you can enjoy those yields on risk-free bonds becomes more acute. At the same time, gold lovers and fiscal crisis enthusiasts are coming out of the woodwork, putting a damper on broader enthusiasm for risky assets.
Investing is never as simple as “big number, sell it all.” But when the mood is nervous, these mind games can have a real impact.
“Five is a really good number,” said Alster of Close Brothers. “As long as we are below five years and inflation data does not deteriorate. . . we can convince ourselves that the next move is down, and I think everything will be fine.
