Last week, the US stock market faced short-term direction choices amidst hesitation. With the landing of heavyweight inflation data, concerns about monetary policy uncertainty have weakened, and risk appetite has helped the Nasdaq and S&P 500 index reach historic highs.
Although speculation about the timing of policy turning points has been constantly delayed since the beginning of the year, investors seem to be nearing the dawn, and for the Federal Reserve, the job market has become a key factor in policy decision-making.
The first interest rate cut further points towards June
Due to the strong increase in service costs, the month on month Consumer Price Index (PCE) in the United States accelerated in January, but the year-on-year growth rate hit a new low in nearly three years, in line with market expectations. At the same time, there are indications that consumer spending has slowed down due to a decrease in spending on goods including cars, furniture, and other durable household equipment. The soft landing situation of inflation and gradual economic cooling is still progressing.
Bob Schwartz, senior economist at the Oxford Institute of Economics, said in an interview with First Financial reporters that recent data has been mixed, and people's judgments on the timing of the Federal Reserve's interest rate cuts are constantly changing. For the Federal Reserve, both doves and hawks can find enough evidence to support their respective positions.
In the past week, the yield of medium - and long-term US Treasury bonds has slightly fallen, with the 2-year US Treasury bond closely related to interest rate expectations falling nearly 16 basis points to 4.53%, and the benchmark 10-year US Treasury bond falling below the 4.20% mark, setting a new three week low. Federal funds rate futures show that investors have further strengthened their expectations for interest rate cuts starting in June.
Institutions have also adjusted the starting point of the new round of easing cycle to the end of the second quarter. Ayhan Kose, Deputy Chief Economist and Director of the Forecasting Bureau of the World Bank, stated at the Global Economic Outlook Academic Dialogue hosted by the International Financial Forum (IFF) that US inflation is falling, which supports the Federal Reserve's interest rate cut process. He stated that due to the persistence of core inflation in the United States, the Federal Reserve will not cut interest rates at its March and May meeting, and will start cutting rates as early as June or later.
Federal Reserve officials have also acknowledged the progress made in combating inflation in recent speeches, but still emphasize that the work is not yet completed as the road to achieving price stability may be bumpy.
As an important advisor to Powell, New York Fed Chairman Williams stated last week that the Fed will still face challenges in the future. "Inflation may rise unexpectedly, or consumer power, the main driving force of the strong growth we see in 2023, may subside faster than I expected." He added that compared with the pre epidemic standard, job vacancies are still "quite high", and the wage growth index continues to be higher than the average level before the COVID-19 epidemic. "We will evaluate future data to ensure that all systems are functioning properly."
Schwartz told First Financial that the Federal Reserve hopes to be more confident that inflation is continuing to move towards 2% before interest rate cuts. Meanwhile, considering the restrictive nature of monetary policy, we are also closely monitoring the impact on the economy. Compared to the Federal Interest Committee (FOMC), he is more concerned about the risk of rapid easing and is more concerned about excessive policy pressure. Schwartz analyzed that if the rate of interest rate cuts is slower than the rate at which inflation subsides, it is equivalent to further tightening, which may increase the risk of economic cooling. History has shown that when the economy and job market begin to show a trend reversal, it is sometimes difficult to prevent the downward speed from accelerating.
Volatility risk still needs attention
Since November last year, the three major stock indexes in the United States have been rising for four consecutive months, largely driven by growth prospects related to artificial intelligence. Last week, Nvidia reached a milestone, with its first closing market value exceeding $2 trillion.
The latest PCE index has strengthened the bet on interest rate cuts in the first half of the year and further ignited the enthusiasm for artificial intelligence. In addition to Nvidia, the strong demand for Generative Artificial Intelligence (AI) has increased investor interest in many other stocks in the AI field. Its competitor AMD also hit a historic high last week, driving the Philadelphia Semiconductor Index up more than 4% last Friday.
Investors are increasingly believing that the Federal Reserve can ultimately achieve a soft landing, which has also boosted market risk appetite. Sam Stovall, Chief Investment Strategist at CFRA Research, said, "Considering the good economic performance and the continued stickiness of inflation, the Federal Reserve has slowed down the pace of interest rate cuts. However, this is also good because we will gradually get out of the high interest rate cycle and there is no need for significant interest rate cuts."
The flow of funds shows that investors have increased their holdings of US stock funds for the third consecutive week. According to data provided by the London Stock Exchange (LSEG) to First Financial, the net inflow of US stock funds reached $2.5 billion last week. It is worth mentioning that, driven by the rise of Bitcoin, all 10 Bitcoin spot ETFs reported net inflows of $1.6 billion, marking the sixth consecutive week of inflows since their launch.
Murphy& Sylvester market strategist Paul Nolte believes that after digesting the PCE report, the prospect of interest rate cuts has once again become clear. "Investors are waiting for the upcoming congressional speech by Federal Reserve Chairman Powell and February employment data to obtain more clues about the path of monetary policy."
Jiaxin Wealth Management wrote in its market outlook report that investors are satisfied with inflation data, coupled with lower US bond yields. Despite some overbought in the market, the path with the least resistance is still upward, and funds continue to flow into the semiconductor industry. From a trend perspective, the "melt up" model of risk assets is still continuing.
The institution believes that employment data for the next week will be a key factor affecting the market. From the recent volatility of the Panic Index (VIX), some investors may seek protection through options to hedge against volatility risks. The trend is still a friend of investors, but future gains may be accompanied by fluctuations, which could lead to market adjustments or demand for profit taking from funds.