Equity Market And Interest Yields Rising, As Rate Cut Expectations Fade Away

Weekly Economic Review: Feb. 12, 2024

After the January FOMC meeting, at which no rate changes were made, and the strong job market data released the following Friday, it’s becoming increasingly clear that the Fed’s stance is exactly as articulated by Fed Chair Powell: that a March rate cut is unlikely, and that future decisions will be based on the economic data that emerges. Should there be any doubt, that message was rein-forced by Federal Reserve officials speaking last week who confirmed they are in no rush to lower interest rates, echoing Chair Powell’s remarks.

Last week was relatively light on economic data, but some new data and other events moved the markets.

On Monday, Feb. 5, 2024 the Institute of Supply Managers survey of the services sector came in stronger than expected. The survey’s overall gauge of services increased 2.9 points to 53.4 last month, hitting a four-month high. This indicates that the service sector expanded in January at the fasted pace in four months. The survey also revealed that prices paid for materials jumped 7.3 points, the most since 2012, to 64 in January, indicating that costs are rising at a faster pace. This increase was mainly driven by higher shipping costs and increases in commodities and services prices. The survey results reinforce the Fed’s view that the U.S. economy remains strong and inflation is still a risk, explaining why the Fed is not in any rush to lower rates.

On the same day, the Fed published its quarterly opinion survey of senior lending officers (SLOOS) for the fourth quarter of last year, indicating that most banks were tightening lending standards, although the proportion of those tightening standards was down from the prior quarter (probably because many banks had already tightened). The report also indicated that, while de-mand for corporate and industrial loans is falling, the severe credit crunch expected in the after-math of last year’s failure of three high-profile regional banks has not occurred.

On Thursday, Feb. 8, 2024 before the Senate Banking Committee, Treasury Secretary Jane Yellen expressed concern that nonbank mortgage lenders could fail in stressful market conditions, as they are highly dependent on short-term lines of credit to fund their residential mortgage loans. Such credit lines are considered much less stable than deposits because, in stressful times, those credit lines can be cancelled. Unlike banks, nonbank mortgage lenders have no access to deposits, nor are they able to utilize Federal Reserve lending facilities. The failure of one or more nonbank mortgage lenders could severely disrupt the U.S. housing market, possibly triggering an economic recession. To guard against this possibility, under last November’s new framework for designating financial firms as systemically important, the Financial Stability Oversight Council (FSOC) has undertaken a process that could result in significantly greater oversight for large nonbank mortgage lenders, hedge funds and investment companies. While the direct impact of this process on interest rates is unclear, the new FSOC oversight is yet another source of uncertainly for market participants to consider.

Last Friday, Feb. 9, the S&P 500 Index crossed over 5,000-point mark for the first time ever, mainly driven by a robust economy, healthy corporate earnings, easing inflation and expectations of future Fed rate cuts. A strong economy and solid corporate earnings are usually more closely associat-ed with interest rate increases rather than cuts, but there is concern that the recent stock rally may not be sustainable, due to its gains being concentrated in big tech companies rather than the broader market.

On a concluding note, we continue to see data pointing in different directions at the same time — robust labor markets, strong economic growth, and easing inflation. Most recently, the Atlanta Fed’s GDPNow tracker forecasts strong first-quarter GDP growth of 3.4%. The resilient economic growth and cooling inflation are expected to continue, subject to potential downside risks such as supply chain disruption and inflation resurgence due to geopolitical issues. But the Federal Re-serve continues to signal that it will be patient and will evaluate incoming economic data over the medium term. Based on the Fed’s push back on immediate rate cuts, the market expects virtually zero probability of a rate cut in March, and at best a 50/50 chance in May. As a result, Treasury yields continued to move higher, with the 10-year Treasury yield increasing by 18 basis points from 3.99% on January 31 to 4.17% last Friday. The 2/10 year yield spread has continued to be inverted by roughly 30 basis points. On the other hand, last Wednesday the Treasury sold a rec-ord $42 billion of 10-year notes with stronger-than-anticipated demand, apparently reflecting inves-tor desire to lock in today’s rates based on an expectation that the Fed will cut rates later this year. Investors appear to be discounting the risks in the commercial real estate sector, which triggered New York Community Bancorp’s reporting of a $252 million loss and a credit rating downgrade to junk status.

Looking ahead, this week the market and the Fed will pay close attention to the second inflation report of the year. On Tuesday, the latest Consumer Price Index (CPI) data will be released, followed by the Producer Price Index (PPI) on Friday. Plus, eight more Fed officials’ speeches are scheduled this week.

Mark Yoon, CFA CPA
EVP & CFO of Commercial Bank of California

Thomas McCullough
EVP of Commercial Bank of California

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