Pre Asia Open: Markets Debate Accelerated Growth V. Moderating Inflation
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US MARKETS
The markets have continued their strong performance at the beginning of 2024, with both inflation and growth factors playing cooperative roles. Last week, the S&P 500 experienced a 1.1% rise, driven by energy and telecom services gains. This positive momentum is underpinned by the US economy's sixth consecutive quarter of growth at 2% or better, even amid over 500 basis points of Fed tightening.
Given the robust economic backdrop, growth projections for the US in 2024 have been revised upwards across “The Steet”. This environment has also provided support for earnings growth, which has been crucial for equities, especially amidst pressure from higher interest rates. With the S&P 500 operating earnings expected to grow around 5% year-on-year, bullish sentiment among investors has become more prevalent, complimented by a notable decrease in bearish sentiment.
BOND MARKETS
In the bond market, yields have seen an increase from their late-2023 lows but remain below the levels seen last fall, suggesting bond bears are being held at bay. Despite firm economic growth, inflationary pressures continue to ease, with core PCE inflation slowing to 1.5% annually over the last three months. While the market continues to debate, even though rate traders got ahead of themselves concerning the timing of expected rate cuts, the almost-priced-to-perfect inflation stability to the end of 2023 is good news. Beyond the timing of rate cuts, the neutral level is also still up for debate, and interestingly, the entire U.S. yield curve is now clustering in the low 4% range, with 5s sitting at 4.0% on the low end and 30s at 4.35% on the high end.
This stable inflation environment, coupled with the ongoing resilience of growth, suggests that markets are adapting to a neutral policy rate that may have moved higher.
FOREX MARKETS
The USD has sustained its upward trajectory in foreign exchange markets, albeit with a slight moderation in its momentum as dollar bulls turn cautious ahead of the upcoming FOMC meeting scheduled this week, which holds sway, as it will offer valuable insights into the Fed's assessment of the juxtaposition between accelerated growth and moderating inflation, which is crucial for shaping the trajectory of monetary policy.
OIL MARKETS
Friday's session witnessed a notable uptick in oil markets as oil contracts settled higher. Last week, sector prices ended with substantial gains across all petroleum contracts, driven by robust macroeconomic indicators from the United States and Reserve Requirement Ratio (RRR) cuts in China. These developments heightened expectations for increased demand in Asia's largest economy, with particular emphasis on the aviation and petrochemical sectors. The confluence of stronger-than-anticipated economic data in the US and strategic policy adjustments in China propelled optimism regarding demand dynamics, underscoring the market's bullish sentiment as the week drew to a close.
CHINA MARKETS
Meanwhile, in China, the government has taken steps to address the downward trend in the stock market and stimulate economic recovery. Measures include a reported RMB2.0 trillion rescue package to purchase stocks, a 50 bps cut in commercial banks' reserve requirement ratio, and new policies to assist struggling property developers. However, it's advised to temper hopes for substantial fiscal and monetary stimulus, as authorities may opt for stop-gap measures over significant interventions, prioritizing technological self-sufficiency and macro-financial stability.
Despite relatively healthy debt ratios at the central and local government levels, which should surprise many, fiscal risks persist due to substantial contingent liabilities from local government financing vehicles (LGFVs) and state-owned enterprises (SOEs). While the debt-to-GDP ratios may appear manageable, the sheer volume of debt, particularly from LGFVs and SOEs, underscores fiscal policy challenges and the need for improved nationwide fiscal discipline and economic efficiency.
In summary, while expansionary fiscal measures could support economic rebalancing and growth, the likelihood of significant policy shifts remains low. Consequently, real GDP growth in China is projected to slow to the low to mid 4 % in 2024, compared to 5.2% last year, due to the cautious stance of authorities amidst ongoing fiscal challenges.
Friday Wrap: A Cautious End To The Week As Event Risk Looms
MARKETS
The week's extensive range of U.S. economic and corporate assessments didn't yield much for markets to worry about, except for potential concerns over rising oil prices or those holding Tesla shares.
The U.S. stock market's strong start to the year faces a significant challenge next week, with a packed schedule that includes crucial tech earnings releases, the Federal Reserve's monetary policy meeting, and the highly anticipated employment report. Additionally, the U.S. quarterly refunding is scheduled for Monday, and the all-consuming US CPI release is on February 11. Given this lineup of critical high-risk events, investors may hesitate to allocate significant capital at this time.
The rise in bond yields at the end of the week presents an unfavourable backdrop for stocks as the probability of a rate cut in March diminishes. This declining probability has put upward pressure on longer-term rates, which often reflect extrapolations of short-term rates.
Shorter maturities led Bond losses, as the latest data indicates personal spending has exceeded expectations. The 0.7% increase in spending marked the most robust growth since September. Notably, it also aligned with the highest estimate among 62 economists. However, the underlying inflation gauge, preferred by the Federal Reserve, has slowed down to an almost three-year low. This mixed bag of data with solid growth prints with disinflation clearly in the pipeline has led to some head-scratching ambiguity among purists.
Even though policymakers have hinted at lowering borrowing costs, they want to see sustainable signs of cooling before taking any such action. Stronger-than-expected consumer data this week, a potential source of consumer-led re-inflation, reinforces the belief that a pivot in March is unlikely.
Investors haven't abandoned their bets on a rate cut in the first quarter but continue to price in a move in May fully. Jerome Powell's messaging at the press conference on January 31 poses a significant event risk, potentially impacting bets on a Q1 rate reduction. But if Powell indicates no rush to ease, it could negatively alter May's and even June's rate cut probabilities.
Given the many risks amid interpreting the data ambiguity in wait, investors have become more cautious about deploying more capital. For the pure macro super forecaster, the current run of solid data amid cooling inflation makes for a somewhat awkward juxtaposition, and what we’re currently witnessing across the US economy, history says, isn’t possible.
One worry hidden in plain sight is that future inflation reports will depend on the impacts of higher oil prices and disruptions in shipping yet to be felt.
EMERGING MARKETS
Investors showed strong interest in emerging market (EM) stocks over the last week, with a record $12.1 billion flowing into EM-focused ETFs and mutual funds, as reported by EPFR's weekly flows update.
This influx suggests that investors are also inclined to rotate and adjust their risk exposure, considering the anticipated rate cuts by the Federal Reserve in 2024, which could benefit emerging markets.
Additionally, concerns about China's equity markets prompted officials to contemplate a two-trillion-yuan rescue package, with the People's Bank of China (PBoC) pre-announcing a required reserve ratio (RRR) cut earlier in the week. Consequently, the CSI 300 and Hong Kong-listed Chinese shares recorded notable weekly gains, although they experienced slight declines on Friday.
Considering China is synonymous with EM, a turnaround in China could bode well for emerging markets. With authorities in Beijing recognizing the urgency of the situation, Chinese shares may present a compelling contrarian opportunity, albeit for investors with a higher risk tolerance.
Of the $12.1 billion inflow, $11.9 billion went to Chinese stocks, presumably reflecting bets on a potential rally orchestrated by the Chinese government.
"Short Chinese equities" have been identified as the second-most crowded trade, so a short covering rally was in the cards. The economy, particularly consumer loan demand, will need to start doing the heavy lifting.
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