The start of the New Year witnessed a market hangover as both stock and bond markets experienced profit-taking following a robust two-month rally. The surge had been fueled by expectations of imminent interest rate cuts by the Federal Reserve (Fed) throughout the year.
Anticipating a series of five rate cuts by 25 basis points each, with the first cut predicted by March (64% probability), investors adjusted their positions. Notably, this probability had receded from approximately 80% at the end of the previous year, reflecting a realization that market expectations had possibly exceeded reality.
The recently released minutes from the Fed’s last meeting offered little clarity, emphasizing the uncertainty surrounding the timing and extent of rate cuts despite acknowledging that rates are ‘at or near their peak’ for the current cycle.
US Economic Data and Rate Cut Speculations:
Despite strong US jobs data for December, featuring over 200,000 new nonfarm jobs and a faster-than-expected acceleration in average earnings (above 4%), rate cut expectations persisted. Some concerns were raised over falling job openings and the participation rate, but the NFP figure above 200,000 did not indicate a severe economic slowdown. Even former Fed Chair Janet Yellen described the current economic situation as a ‘soft landing,’ suggesting a more gradual approach to rate adjustments.
Market Reactions and Rising Yields:
The New Year saw a rebound in the US 2-year yield to 4.40%, and the 10-year yield surpassed 4%, marking the most significant weekly advance since October. These rising yields halted the dollar‘s decline, causing the EURUSD to dip below 1.10. Equities also faced headwinds, with the S&P500 dipping below 4700, and the Nasdaq 100 experiencing a more than 4% decline from its December peak.
Upcoming US Inflation Data and Inflation Risks:
This week’s focal point is the US inflation data, with expectations of a slight acceleration in headline inflation to 3.2% and a further easing in core inflation to 3.8%. Soft inflation numbers could potentially temper corrective selloffs in both stock and bond markets. However, inflation risks, especially related to increased shipping costs due to tensions in the Red Sea region, present an upside risk. Shipping costs from Asia to Europe and America have doubled since last December, potentially impacting inflation figures in the coming months.
Oil Prices and Geopolitical Risks:
Despite geopolitical tensions in the Red Sea region, oil prices have encountered strong resistance. The barrel of US crude struggled to breach the $74 level last week, starting the current week below $73. Geopolitical risks persist, but efforts to keep oil prices below $70 demonstrate traders’ resistance to pushing prices higher.
As markets grapple with shifting rate cut expectations, upcoming inflation data and geopolitical influences pose significant variables. The ongoing balance between economic indicators, central bank actions, and external geopolitical factors will likely continue shaping market trends in the weeks ahead.