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On Wednesday, U.S. stocks experienced a significant surge as investors assessed robust corporate profits and witnessed major technology companies extending their upward trajectory. These movements occurred amidst ongoing discussions regarding the timing of potential interest rate cuts.
Even as U.S. yields backed up a touch, notably, the S&P 500 approached the 5,000 mark for the first time, hinting at mega-cap tech’s de-coupling from bond yields but supported by an upbeat macro story, where the economy continues to operate at an above-trend pace with no material signs of falling below trend in the near-term. Indeed, higher rates don’t appear to burden consumers or corporations significantly, enabling the Fed to wait longer to ensure inflation control without disrupting the stock market’s momentum amid robust U.S. growth dynamics.
While revelling in the glow of robust macro growth, market participants took stock of corporate performance during this earnings season, with approximately two-thirds of S&P 500 company reports now available. Overall, results have surpassed Wall Street expectations on average, overshadowing weakness in other less weighty areas at the index level.
It’s becoming increasingly evident that equities are unfazed and indifferent to the Federal Reserve’s less dovish stance, which suggests that unless there is a substantial deterioration in the labour market, the central bank’s baseline expectation for 2024 includes three rate cuts.
As the year began, following a risk rally in November and December primarily driven by increasing bets on rate cuts and declining bond yields, there was significant speculation about whether stocks could maintain their strength if market expectations for Fed easing diminished.
Market pricing still suggests more easing compared to the last dot plot released by the Federal Reserve. However, when you delve into what drives that pricing – the array of potential macro-policy scenarios and the probabilities traders attach to them – it’s reasonable to argue that the rates market’s “base case” now aligns closer with the Fed’s projections.
Indeed, the “extra” cut premium above and beyond 75 basis points reflects two main hedge factors:
i) Traders’ assessment of the Federal Reserve’s willingness to act decisively in response to devolving economic conditions.
ii) The perceived probabilities traders assign to various tail risks, including geopolitical events, economic shocks, and other unforeseen developments that could impact the economic outlook and necessitate policy adjustments by the Fed.
The current market pricing, as of Wednesday, incorporates an expectation of a 75 basis point reduction in interest rates, along with a fair-minded premium intended to address lingering concerns about the possibility of a hard economic landing.
Interestingly, equities seem to have become indifferent to the movements in rates and bonds, particularly after the Federal Reserve removed its tightening bias. The behaviour of rates and bond markets is cartoonish and probably worth ignoring as bond bears are, for all intent and purposes, in hibernation.
While it’s tempting to subscribe to market pricing as a more accurate gauge of future policy trajectories compared to official statements from the Fed, it’s important to note that rate markets have been forever in overshoot and undershoot mode throughout this economic cycle. Hence, seldom have rates speculators have been the absolute guiding light
In summary, every corner of Wall Street has revised its U.S. growth forecast upward for 2024. This optimistic backdrop has also supported earnings growth, which has been crucial for equities, particularly amid pressure from higher interest rates. As we progress through the fourth-quarter reporting period, S&P 500 operating earnings growth is much better than expected and has effectively diminished the influence of bearish sentiment in the market.
Oil Markets
Oil futures rallied Wednesday after the Energy Information Administration (EIA) released its weekly inventory statistics. This surge was driven by a larger-than-anticipated decline in U.S. fuel stocks and escalating geopolitical tensions in the Middle East.
Gasoline inventory in the United States experienced a drawdown of 3.146 million barrels (bbl) to 250.988 million bbl during the week ended February 2, according to the Energy Information Administration (EIA). This drawdown, the first since mid-December, was attributed to higher demand and reduced production. Gasoline stocks transitioned from 3.053 million bbl above the five-year average to 1.701 million bbl below the historical baseline. The drawdown contrasted with a 3.652 million bbl build reported late Tuesday by the American Petroleum Institute. Hence, the bullish inflection point.
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