WEEK AHEAD 

In the upcoming sessions, the direction of US interest rates is expected to be influenced by economic data releases and the market's response to the Treasury supply dynamics.

When the Fed goes silent ahead of the January policy meeting, the market does not necessarily fly blind; instead, it creates an environment where market participants will zero in on incoming economic data. Additionally, the market's response to the issuance of new bonds, reflecting the supply of government debt dynamics, will be closely watched. Investors will assess how demand for these bonds impacts yields for short-, medium-, and long-term interest rate expectations.

In the early months of 2024, Treasury prices have declined, leading to higher yields. Despite the rise in bond yields, equities have not been significantly impacted, and the S&P 500 even achieved a new record high. This occurred despite the notable yield increase at the front end of the yield curve against a backdrop of resistance from policymakers who expressed concerns about aggressive pricing for potential rate cuts.

But as discussed at length last week, the prevailing sentiment suggests that the path of least resistance for the Fed is leaning toward a minimum of 75 bp of insurance rate cuts this year. But the key uncertainties revolve around the pace of cuts and, perhaps significantly, the timing of such monetary policy adjustments.

However, we will likely have a better idea of where March cut probabilities sit after Friday’s release of the US PCE deflator report for December, which is anticipated to provide evidence that inflation is slowing and possibly tipping the scales in favour of the March rate cut.

Nonetheless, it was somewhat refreshing to witness stocks moving higher in response to positive macroeconomic data, suggesting that good news may once again be interpreted positively in the market. To the degree this good news is good news, the environment holds up. We will soon find out by the end of the week.

The upcoming critical macroeconomic event leading to this month's Federal Open Market Committee (FOMC) meeting is the advance reading on the fourth-quarter US Gross Domestic Product (GDP). Consensus forecasts anticipate a 2% growth rate for the headline GDP figure and a 2.5% expansion in the personal consumption component. Investors will closely watch these figures as they provide insights into the overall economic performance and consumer spending trends, potentially influencing market sentiment and expectations leading to the FOMC meeting.

As of January 19, the Atlanta Federal Reserve's GDPNow forecast stands at 2.4%, offering an early indication of the potential growth rate for the current quarter.

While there may be a temptation to anticipate the risk associated with a strong GDP reading leading markets to adjust their expectations for a March rate cut, the broader focus could shift toward the core Personal Consumption Expenditures (PCE) metric. Notably, the final reading for the third quarter GDP revealed a downward revision in the core PCE print to 2%. Investors will likely pay close attention to this inflation measure, which is crucial in shaping monetary policy decisions.

The impact of these developments on the likelihood of a March Fed rate cut remains a matter of debate. The upcoming pivotal event is Jerome Powell's press conference on January 31, where his messaging could significantly influence the betting odds for a Q1 rate reduction. The Federal Reserve will have input from additional data points by March, which will likely substantially impact market expectations more than the events in the coming week.

There is a conceivable threshold regarding equities where a reduced expectation of Fed cuts could turn negative without a corresponding acceleration in earnings growth expectations. However, the stock market has experienced a positive trend in 2024, with traders trimming March rate-cut odds to around 40% last week and implied cuts for 2024 by approximately 30 basis points. Surprisingly, this adjustment did not hinder equities from reaching new highs.

FRIDAY RECAP ( A Goldilocks End To The Week)

On Friday, the major U.S. stock indexes experienced gains, with the S&P 500 poised for its first record close in over two years. Tech stocks, including Nvidia, AMD, and Texas Instruments, led the rally.

Despite a case of the early week "hic-ups" triggered by policy uncertainty about the Federal Reserve's potential rate cuts in March and 10-year US Treasury yields holding above 4%, the S&P 500 summit climb ensued on Friday.

To suggest that January's market activity has been messy would be an understatement, with far more cautious sentiment prevailing, particularly given global Central Banks’ pushback on the bullish thesis around early rate cuts.

The proximate cause of what appeared to be coordinated Central Bank pushback was global core inflation, which experienced a notable increase. The estimated 1-month annualized rate rose to 2.6% in December from the previous rock-bottom reading of 1.2% in November. This uptick has reignited concerns that the disinflation observed in 2023 may not be a lasting trend. Some argue that it resulted from a one-off improvement in goods supply, leading to a temporary decline in goods prices, while service inflation remains entrenched.

But many others feel there is enough disinflation in the pipeline, and the adjustment in core goods prices is still incomplete, with, for instance, US used cars having unwound only 31% of their COVID-related price increase. And anticipate that service inflation and wage growth will continue to slow gradually. This slowdown is expected to be a lagged response to the improved supply/demand balance across the global economy. Hence, central banks may need another month or two of inflation data before initiation rate cuts. However, a March could still happen, making the December reading on the PCE deflator, due on January 26, significant in this context.

And even amid the re-rating of March rate cut probabilities, it remains a coin toss, while the futures curve is still pricing in a 140 bp of cuts for 2024. Hence, the prevailing sentiment is still tilted toward "buy-the-dip," as the potential upside in the year's first half outweighs the downside.

In addition, the recent adjustment in expectations for Fed rate cuts should be seen as the market assigning a lower probability to a recession scenario, providing relief to equities, even though it entails an effective "tightening" as the market had previously priced in for nearly 7 cuts for 2024.

But avoiding a recession with insurance cuts in the pipeline is undoubtedly a more favourable outcome than facing a hard landing with panic cuts.

Notably, a soft landing for the economy came into better focus this week, as solid growth in December provided a robust start to 2024. This positive development suggests a balanced and controlled economic slowdown rather than a sudden and sharp contraction, easing concerns about a potential recession.

In early January, consumer sentiment experienced a significant improvement, while inflation expectations continued to decrease, according to the preliminary reading of the University of Michigan sentiment released on Friday. The headline gauge, which also saw a substantial increase in December, rose to 78.8, marking a 13% gain. Notably, the month-to-month increase of 9 points was even more extensive than the notable jump observed in December, with last month's higher percentage increase. This data suggests a positive shift in consumer moods and a further easing inflation concerns among the surveyed individuals.

In encouraging developments for the Federal Reserve and market participants, the downward trend in inflation expectations observed in December continued. Year-ahead expectations decreased to just 2.9%, extending the momentum from December when the 12-month outlook saw a significant drop from 4.5% to 3.1%. The decline suggests a positive perception shift regarding future price increases among surveyed individuals.

Fortunately, Friday's University of Michigan sentiment report was a Goldilocks release. Consumer moods experienced a significant improvement for a second consecutive month, while inflation expectations continued to recede further.

ASIA OPEN  (With A Spring In Their Step)

With a spring in their step, investors took Asia-Pacific markets higher on Monday, mirroring the gains in Wall Street after a rally in technology stocks propelled the S&P 500 to an all-time high on Friday.

The S&P 500 climbed 1.2% to 4839.81, breaking a streak of over 500 trading sessions without reaching a new record. The Dow Jones Industrial Average also hit a record, gaining 395 points or 1.1%, to close at 37863.80. The tech-heavy Nasdaq Composite rose 1.7%.

The Bull was untethered after Taiwan Semiconductor Manufacturing (TSM) became the world's largest contract chipmaker. On Thursday, it projected more than 20% growth in 2024 revenue on booming demand for high-end chips used in AI.

A more positive mood among Americans from the University of Michigan survey suggests happier consumers are more likely to continue spending. Consumer spending accounts for around two-thirds of the U.S. economy. Other indicators also suggest that Americans are emerging from a period of pessimism.

 According to a Federal Reserve Bank of New York survey, the share of consumers in December expecting to be financially better off a year later reached the highest level since June 2021. Additionally, a consumer confidence measure from the Conference Board in December saw its most significant one-month gain since March 2021.

 U.S. futures may experience a holding pattern as major U.S. macro events and corporate profit reports featuring big Tech names like Tesla, Intel, Netflix, IBM, and Seagate take center stage amid the thick of earnings season. 

The current state of Chinese stocks hovering around five-year lows, with foreign capital outflows and a declining yuan, has heightened pressure on Beijing to take action. However, policymakers are cautious due to concerns about increased debt load and fears of triggering foreign exchange outflows.

On Monday, the central bank is anticipated to keep the benchmark one- and five-year loan prime rates (LPR) unchanged at 3.45% and 4.20%, respectively. The question now is whether this will bring more disappointment to investors or if these expectations are already factored into the currency and stock prices.

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