That smell in the market is fear
In truth, for the first time this year
As both bonds and stocks
Are now on the rocks
And no sign t’will soon disappear
 
The Fed is remaining on hold
Though elsewhere, rate cuts are foretold
But worries abound
As risk is unwound
That everything soon will be sold

 

It is very difficult to get excited about much in the markets these days as we see stocks, bonds and commodities all slide in price.  The fear in markets is palpable as investors and traders clearly remember 2022, when both stocks and bonds fell sharply and those holding the traditional 60/40 portfolio got crushed.  This is not to say that we are seeing the same thing right now, but the very fact that we can have both asset classes suffer simultaneously, even for a few days, is disconcerting to everyone.

It is difficult to pin down a specific driving force right now as opposed to the 2022 scenario when the Fed was raising the Fed funds rate aggressively amid a serious bout of inflation.  But currently, there are a relatively equal number of pundits and analysts on both sides of the inflation and growth debate.  With this as the case, it doesn’t seem logical that there would be a significant trend shift.

So, this morning let’s try to consider the current stories that may be driving this recent bout of investor skepticism.  On the macro side of things, while recent data hasn’t been awful, it has hardly been scintillating.  For instance, the recent Dallas Fed Manufacturing Index was quite weak, similar to what we saw with Philly and Empire State, but the Richmond number rebounded.  While we all await this morning’s second look at Q1 GDP (exp 1.3%, down from the initial reading of 1.6%), there is much more focus on tomorrow’s PCE data.  In fact, given the dour mood in the market, it is hard to remember that the CPI data earlier this month was seen as a slight positive.  

But bigger problems reside in the Retail Sales and consumption story on the micro side of things as we have been hearing from an increasing number of companies that customers are balking at higher prices.  Retail Sales were flat in April, hardly a sign of strength, and just this morning we had Walgreens say they will be cutting prices on 1500 items in their stores in an effort to stimulate sales.  We heard bad tidings from Target earlier this month, as well as McDonalds, Starbucks and Walmart.  

It is certainly difficult to hear these reports and come away feeling bullish about either the economy or the equity markets.  Yesterday’s Fed Beige Book was its usual mix of some good and some bad, but no strong trend in either direction.  Atlanta Fed president Bostic explained yesterday that “My outlook is that if things go according to what I expect — inflation goes slowly, the labor market slowly and orderly moves back into a sort of a weaker stance, but a stable-growth stance — I’m looking at the end of the year, the fourth quarter, as the time where we might actually think about and be prepared to reduce rates.”  That sounds like a December cut, a far cry from expectations just last week, let alone the beginning of the year.

In fact, I challenge you to come up with a bullish piece of news that may drive sentiment back toward overall risk bullishness.  Arguably, the only thing around is Nvidia, which is pretty thin gruel on which to sustain a global economy!  And ask yourself, how much of that is overdone?

Looking elsewhere in the world doesn’t make you feel much better either.  For instance, in Europe, while a rate cut next week seems certain, this morning’s Unemployment release showing a decline to 6.4%, the lowest level ever recorded, is hardly cause for the ECB to get aggressive in cutting rates further.  Similarly to the US, with unemployment so low, and inflation remaining well above target, please explain why any central bank would feel compelled to cut rates.

Summing up, it is quite easy to make the case that risk assets have gotten far ahead of themselves on the hope that the global interest rate structure was going to decline thus allowing the leverage that had been implemented during the post-Covid ZIRP and NIRP regimes to be refinanced at more attractive levels.  However, as the data continues to show more resilience than expected in both the employment and inflation regimes, central banks find themselves with few good reasons to cut rates despite their very clear bias to do so.  And now that each move and utterance they make is scrutinized so closely, they have limited incentive to act.  Here’s my take; while we may see some initial rate cuts by the ECB, BOE and BOC, do not look for a long cycle absent a significant decline in inflation or sharp rise in unemployment, neither of which seems imminent.

Ok, the negativity in the US yesterday followed through to Asia with all markets lower there, some by a bunch like the Nikkei (-1.3%) and the Hang Seng (-1.3%) while others were merely down by -0.5% or so.  However, in Europe this morning, bourses have edged a bit higher with one outlier, Spain’s IBEX (+1.25%) the biggest beneficiary after inflation numbers from that nation proved cooler than expected.  Alas, at this hour (7:30) US futures are lower by -0.5% or so after a weak Salesforce earnings report last night.

In the bond market, the last two days of higher yields has halted for now with Treasury yields lower by 2bps and European sovereigns trading in a similar manner.  Yesterday’s 7-year Treasury auction was also soft, although the bid-to-cover ratio was 2.37, not as low as the 5-year the day before.  However, confidence in the ability of the market to continue to absorb the number of Treasuries required to fund the government deficit appears to be slipping, at least a little.

In the commodity markets, oil is unchanged this morning, consolidating its recent gains as traders await the latest OPEC news from a meeting scheduled for next week.  In the metals markets, gold is also little changed this morning but both silver and copper are under pressure as they continue to give back some of their recent substantial gains.  For instance, even after today’s -2.2% performance in silver, it is higher by 4% in the past week and 17% in the past month.  

Finally, the dollar is under some pressure this morning following several days of strength on the back of the higher US yield story.  The biggest G10 movers are CHF (+0.7%) and JPY (+0.6%) as the former responds to comments from the SNB hinting that further rate cuts may be delayed over concerns of the franc weakening too quickly, while the latter looks mostly like a trading response as there were no comments or data to drive things. After all, despite the threat of intervention, the yen has been sliding consistently of late.  In the EMG bloc, it is a different story as the only noteworthy gainer is CNY (+0.25%) while ZAR (-0.7%) on the back of uncertainty regarding the election outcome, and KRW (-0.5%) on the back of continued weakness in the KOSPI index, cannot find any support today.

On the data front, in addition to the GDP data mentioned above, we see the weekly Initial (exp 218K) and Continuing (1800K) Claims as well as the Goods Trade Balance (-$91.8B).  Alongside the GDP data are a series of other indices like Final Sales (2.0%) and Real Consumer Spending (2.5%) which are important numbers to get a more holistic view of the economy.  Of course, it wouldn’t be a day ending in “Y” if we didn’t have more Fed speakers, with two more on the docket, Williams and Logan.

It is tough to fight a sentiment that is turning negative.  While I would expect the dollar to benefit from this, right now it is a mixed picture.  I doubt either Fed speaker will break new ground, so I fear that the overall negativity is going to be today’s key theme.  Lower stocks, lower bonds and a mixed dollar like we’ve seen overnight seem likely to be what we see in the US.

Good luck

Adf