Last week, 10-year US Treasury yields rose to levels not seen since November of last year. This was due to the higher than expected US Consumer Price Index (CPI) released a few weeks ago, which caused markets to change their collective view on Federal Reserve (Fed) policy this year. That view was bolstered by last week’s retail sales report, which came in well above expectations, as well as hawkish remarks from members of the Federal Open Market Committee. A few sentences from last week:
• Fed Vice Chairman Philip Jefferson: “If further data indicates that inflation is more persistent than I currently expect, it will be appropriate to maintain the current restrictive policy stance for longer. I am fully committed to getting inflation back to 2%.”
• From Fed Chairman Jay Powell: “Recent data clearly did not give us more confidence and instead suggest that it will likely take longer than expected to achieve that confidence. Right now, given the strength of the labor market and the progress on inflation so far, it is appropriate to give the restrictive policy additional time to work and let the data and the evolving outlook guide us. If higher inflation persists, we can maintain the current level of restrictions as long as necessary.”
• New York Fed President John Williams: “We have interest rates that are gradually moving us toward our goals, so I certainly don’t feel any urgency to cut interest rates.”
Oil prices fall despite tensions in the Middle East
West Texas Intermediate crude oil prices actually fell from recent highs last week. This was surprising to some given the high tensions in the Middle East, but I think it reflects a few key factors:
• First, US oil production has been a game-changer in mitigating the impact of geopolitical risks in the Middle East on oil prices. According to the US Energy Information Administration, the United States is the largest producer of crude oil as of 2018. Its 2023 production of 12.9 million barrels per day was much higher than that of the second largest oil producer, Russia, at 10.1 million barrels per day, and Saudi Arabia at 9.7 million barrels per day.
• Tensions in the Middle East are high, but not as high as many feared. The measured reactions between Iran and Israel are, in my opinion, very controlled, they intend to express dissatisfaction with the previous act of aggression, but apparently to prevent the escalation of military actions.
• Also, the new conventional notion that rates will be higher for a longer period of time is expected to cause some demand destruction, which I believe has also put some downward pressure on oil prices.
Hopes for faster disinflation persist in the UK
The latest readings of the UK Consumer Price Index have supported the view that UK inflation will remain. Inflation in services moderated, but not as much as market watchers would have liked. In addition, UK wage growth also slowed less than expected. This caused the markets to change their collective view on when the first rate cut by the Bank of England would take place.
However, I am hopeful that the rate cut will happen before the end of the second quarter. That’s why I was reassured by the words of Bank of England Deputy Governor David Ramsden, who said: “Given that we know the Ofgem price cap for April, and also taking into account the fuel duty freeze in the March Budget, then we can be sure that when ceteris paribus, headline CPI inflation will fall sharply in April and approach the 2% target.” later.
The Eurozone is making significant progress in disinflation
Year-on-year inflation in the eurozone for March stood at 2.4%, down from 2.6% in February and 2.8% in January. This is impressive progress considering that a year ago the inflation rate was 6.9% year-on-year. Core inflation, excluding food and energy, was also unrevised at 2.9% year-on-year in March – and also 2.6% excluding tobacco. In my opinion, this development virtually guarantees that the European Central Bank will proceed with a rate cut at its June meeting.
China and Canada
It’s also worth noting that China’s first-quarter gross domestic product surprised positively and beat expectations. This suggests that targeted fiscal stimulus improves confidence and has a positive impact on the economy.
Meanwhile, Canada’s federal budget for 2024 was released last week. While it contains some interesting proposals that could boost economic growth and help increase household financial stability, it also raises concerns about the government’s debt and the high cost of servicing it—though not nearly as much significant, such as concerns expressed south of the Canadian border, in the US.
Implications for Assets
Risk assets are clearly under pressure and are likely to continue to be under pressure, but with higher yields. However, I believe that this too shall pass. I also believe that a Fed rate cut in June and a total of three rate cuts this year are still very real possibilities. However, markets are unlikely to change their minds – and hence pressure on risk assets is unlikely to ease – until significant data emerges that show more progress in disinflation and a “less hot” economy.
As I ponder my hopes for the upcoming dates, I am reminded of something Antonio Salieri, Wolfgang Amadeus Mozart’s rival (at least in the film) is said to have said: “I speak for all the average. I’m their advocate… I’m the patron saint of mediocrity.” Well, we could use some Salieri-type CPI and retail sales data in recent weeks. And I’m hoping for some Salieriian moments in the coming weeks and months in US economic data — average inflation data and general economic data that don’t surprise on the upside.
Once we get more evidence of disinflationary developments in the US, there is cause for optimism. I think the decline we’ve experienced is healthy. Valuation of risky assets is then more attractive. There is still considerable cash in the secondary markets that could move into the markets. After all, this opinion is supported by the comment of the financial director of one of the world’s major banks, which was made last week as part of an interview about the economic results: “…there is a lot of cash here at the moment. This could tell you that this supports the ability to see continued flows of assets under management into the future, depending on how… of course, the stock market develops over time. But we’re all struck by the sheer amount of cash that’s on the sidelines at the moment.” I don’t think this is an anomaly; I suspect many banks are seeing increased amounts of cash lying around.
Tags: Invesco Rising Treasury yields falling oil prices hawkish Fed talk
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