Fading Hopes for Rate Cuts

By JSF Financial on May 24 in highlights, Market Update

Quick Take: Lingering inflation weighs on investors.^[1] With as little as one rate cut now anticipated for 2024, Treasuries sold off, sending yields higher and stocks lower.^[2]

As investors focused on disappointing inflation readings, major equity indexes ended a five-month winning streak to move lower in April.^[3] By the close of the month, the technology-heavy NASDAQ was down 4.4%, while the S&P 500 lost 4.2%.^[4]

The main concern is that stubborn inflation could prompt the Federal Reserve (“Fed”) to keep interest rates restrictive for longer and push back rate cuts. At the same time, the market has to contend with how much this dynamic may slow down the economy.

Anticipation of prolonged high interest rates led bond yields to climb, which can dampen expectations of future growth prospects for stocks. However, despite losing some ground, the S&P 500 is still higher than its October 2023 low by over 20%.^[5]

Inflation Lingers

During the first quarter, which was the strongest since 2019, the market seemed to overlook rising yields thanks to strong economic performance. The economy continues to be bolstered by resilient earnings – early indications from the Q1 reporting season point to over 80% of US companies beating expectations.^[6]

Recent data signals a mix of slower growth and higher-than-expected inflation underpinned by a strong labor market. Key numbers include:

– Slower growth: First quarter GDP growth, a measure of economic output, increased by 1.6%, well below expectations.^[7]

Source: https://www.cnbc.com/2024/04/25/gdp-q1-2024-increased-at-a-1point6percent-rate.html

– Stubborn inflation: Inflation as measured by the personal consumption expenditures (PCE) index rose at the fastest pace in a year.^[8] The PCE came in slightly above estimates and is the Fed’s preferred measure of inflation.^[9]

Source: https://www.reuters.com/markets/us/fed-holding-pattern-inflation-delays-approach-any-soft-landing-2024-04-29/

– Robust labor market: Even while raising wages, U.S. employers hired far more workers than expected in March.^[10] The cost of labor rose in the first quarter at the fastest pace in over a year and above estimates.^[11] In other notable moves that have yet to take effect, the Federal Trade Commission voted to ban noncompete agreements, and the Biden administration finalized a rule to make millions more salaried workers eligible for overtime pay.^[12]

The last three months of disappointing inflation readings mean that inflation will take longer than previously expected to decline.^[13]

Federal Reserve Chairman Jerome Powell commented: “More recent data shows solid growth and continued strength in the labor market, but also a lack of further progress so far this year on returning to our 2% inflation goal.”^[14]

Lingering inflation will likely delay the start of interest rate cuts.^[15]

Treasury Yields Soar

Shifting expectations about monetary policy sent Treasury yields soaring over the past month, and the 10-year had its biggest monthly increase since September 2022.^[16], ^[17] Treasury yields and prices have an inverse relationship: yields increase as prices decrease.

During the month, the yield on the benchmark 10-year note hit a notable five-month high at 4.7%. Investors are bracing for a possible move towards last October’s 16-year high of 5%.^[18]

Source: https://www.cnbc.com/2024/04/30/this-is-where-the-10-year-yield-is-a-clear-problem-for-stocks-goldman-says.html

The 10-year yield is vital because it is used as a benchmark for borrowing rates on everything from mortgages to loans and corporate debt. As yields rise, borrowers with floating rates are directly impacted by higher payments. Demand for new loans may also take a hit as borrowing gets more expensive.

As we hit the summer season, when real estate inventory typically picks up, mortgage rates are top of mind for buyers and sellers. Mortgage rates are hovering above 7% as they track the 10-year Treasury yield, which has risen for four straight weeks.^[19]

The silver lining is that other factors besides the Fed can influence mortgage costs. According to the Wall Street Journal, the variation in borrowing rates between lenders has grown since the Fed started hiking interest rates in 2022.^[20] It pays to shop around for mortgages – you might see very different quotes that could make a difference of tens of thousands of dollars.

The Wealth Effect

So far, higher interest rates in 2024 have not depressed record-high home values and have barely made a dent in stock market valuations.^[21], ^[22]

Source: https://apnews.com/article/inflation-economy-wealth-rates-federal-reserve-cuts-9290216e89cbd7a3a0d2be66041aeaf8

American household wealth has soared since the pandemic, though the wealthiest one-tenth of Americans own two-thirds of all household wealth.^[23] Consumers who own assets like stocks, bonds, and property, are benefiting from market gains and may even be collecting more income from higher-yielding bonds.

This wealth effect – even if it’s not evenly distributed – inspires confidence to spend, which has powered the economy.^[24] It’s also contributing to the sticky inflation that is delaying rate cuts.

What’s Next

At the policy meeting at the beginning of May, the Fed left interest rates unchanged and continued to maintain that rate cuts would be data dependent.^[25] After starting the year expecting six rate cuts, the market now expects closer to one.^[26] Equities are experiencing all-time highs and overall financial conditions are relatively moderate.^[27]

Investors seem to be betting that even with a little inflation, the economy remains in good shape. Positive earnings results and economic reports in the first quarter support this view.^[28] However, the market is driven by more than the economy, and the undercurrents brewing can be complex to pick apart.

The best long-term solution to facing uncertainty and volatility is adopting a personalized and proactive investment. We encourage you to stay engaged, ask questions, and reach out to notify us of any changes in your circumstances.

To our graduating students, we recognize the unique challenges you’ve faced since the pandemic. We admire your resilience and spirit as you make sense of these divided times. Even amidst uncertainty, you will step into a world of possibilities.

Please check in with us if you have any updates or concerns. Our team always looks forward to hearing from you and we hope you’re enjoying the end of a beautiful spring!

From Your Friends at JSF

The information expressed herein are those of JSF Financial, LLC, it does not necessarily reflect the views of NewEdge Securities, Inc. Neither JSF Financial LLC nor NewEdge Securities, Inc. gives tax or legal advice. All opinions are subject to change without notice. Neither the information provided, nor any opinion expressed constitutes a solicitation or recommendation for the purchase, sale or holding of any security. Investing involves risk, including possible loss of principal. Indexes are unmanaged and cannot be invested in directly.

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The Bloomberg Barclays U.S. Aggregate Bond Index measures the investment-grade U.S. dollar-denominated, fixed-rate taxable bond market and includes Treasury securities, government-related and corporate securities, mortgage-backed securities, asset-backed securities and commercial mortgage-backed securities.

The S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market.

TLT-iShares 20 Plus Year Treasury Bond ETF seeks to track the investment results of an index composed of US Treasury bonds with remaining maturities greater than twenty years.

The Nasdaq Composite is a market-capitalization-weighted index consisting of all Nasdaq Stock Exchange listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds or debenture securities.

Treasury Bond- is a U.S. government debt security with a fixed interest rate and maturity between two and 10 years.

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[1] https://www.wsj.com/economy/central-banking/us-gdp-economy-first-quarter-2024-1675df05

[2] Soaring Treasury Yields Challenge Stock-Market Gains | The Wall Street Journal

[3] Stocks Slip, Extending April Pullback | The Wall Street Journal

[4] Stocks Slip, Extending April Pullback | The Wall Street Journal

[5] Dow tumbles 570 points to wrap worst month since September 2022 as bond yields rise | CNBC

[6] https://www.bloomberg.com/news/articles/2024-04-28/asian-markets-eye-positive-open-tech-in-focus-markets-wrap

[7] Mix of Slowing Growth, Firm Inflation Worries Investors | The Wall Street Journal

[8] GDP growth slowed to a 1.6% rate in the first quarter, well below expectations | CNBC

[9] GDP growth slowed to a 1.6% rate in the first quarter, well below expectations | CNBC

[10] March US payrolls beat expectations; wages increase steadily | Reuters

[11] Treasury yields finish April with biggest monthly jumps since 2022-2023 | Morningstar

[12] What to know about US changes to ‘noncompete’ agreements and overtime pay | AP News