Rate Cuts This Summer? Jan. 17, 2024

Markets are being rattled this morning on the back of ECB President Christine Lagarde projecting that the central bank will begin to cut rates this summer. The UK also reported hotter inflation data, indicating more robust price pressures than initially expected, prompting increased investor attention. Additionally, higher-than-anticipated figures in the United States related to retail sales, industrial production, and homebuilder sentiment exerted further pressure on asset prices. Conversely, disappointing data from Beijing was weighing on oil prices while pressuring Chinese stocks.

Lagarde, UK Inflation Weigh on Investor Sentiment

ECB President Lagarde criticized aggressive bets favoring rate cuts, stating that they are distracting and unhelpful for global central banks in addressing inflation. Following her comments, which emphasized resistance to looser financial conditions, UK inflation exceeded expectations significantly. Prices in the Kingdom rose by 0.4% month-over-month (m/m) and 4% year-over-year (y/y), surpassing forecasts of 0.2% and 3.8%, and exceeding the previous month’s figures of -0.2% and 3.9%. Core prices, excluding food and energy, experienced a 0.6% m/m and 5.1% y/y increase, higher than estimates of 0.4% and 4.8%, and surpassing November’s -0.3%. Various categories contributed to the price surge, including furniture and household goods, alcohol and tobacco, transportation, food markets, health, restaurants and hotels, apparel, and shelter, with m/m increases ranging from 0.4% to 1.4%. While the other categories saw gains of 0.3% or less, communication and miscellaneous goods and services provided relief, declining by 0.6% and 0.3%.

Retail Sales Reflect a Strong Consumer

In the United States, consumers closed out 2023 on a high note, driven by robust holiday shopping. Retail sales surged a notable 0.6% in December, surpassing the median forecast of 0.4% and November’s 0.3% growth. When excluding automobiles, sales increased by 0.4% and when further excluding automobiles and gasoline, sales rose 0.6%. The strong consumption trend was evident in various sectors, including apparel establishments, e-commerce destinations, general merchandise stores, automobile dealerships, and miscellaneous retailers, experiencing m/m sales growth of 1.5%, 1.5%, 1.3%, 1.1%, and 0.7%, respectively. Building materials shops, sporting goods suppliers, and food markets also contributed to the overall positive figure, with transactions rising more modestly at 0.4%, 0.3%, and 0.2%. However, health retailers, gasoline stations, furniture showrooms, and electronics stores offset some of the gains with m/m declines of 1.4%, 1.3%, 1%, and 0.3%. Dining and drinking establishments remained unchanged during this period.

Lighter Rates Contribute to Homebuilder Sentiment and Industrial Production Beats

Homebuilder sentiment improved in January, driven by lighter mortgage rates that enhanced conditions for both buyers and sellers. The National Association of Home Builders and Wells Fargo Homebuilder Sentiment reached 44, marking the highest level since September. This exceeded estimates of 39 and surpassed December’s figure of 37. The most significant contribution to this improvement came from the outlook for sales in the next six months, while current sales and buyer traffic also contributed, albeit at more moderate rates.

Industrial production barely progressed in the last two months of 2023. Still, production rose 0.1% in December, higher than projections calling for no change from the previous results of 0, which would have been identical to November. Mining and manufacturing production contributed with m/m gains of 0.9% and 0.1% while utilities served as a drag, declining 1% during the month. Across products, consumer goods and materials production gained 0.2% and 0.1% during the month while business equipment and construction supplies declined 0.2% and 0.1%.

Chinese Performance Remains Lackluster

Shifting east, Chinese consumption is facing a slowdown, influenced by a challenging export outlook and weaknesses in the real estate sector, impacting overall economic prospects. Retail sales growth decelerated to 7.4% y/y in December, falling short of expectations set at 8% and significantly lower than November’s 10.1%. Additionally, fourth-quarter GDP growth failed to meet expectations, registering at 5.2% instead of the anticipated 5.3%. These indicators reflect the ongoing challenges and headwinds affecting China’s economic landscape.

Commercial Real Estate and FDIC Fees Weigh on Banks

Bank earnings released this morning show the impacts of a weakening real estate market and special regulatory charges for shoring up the Federal Deposit Insurance Company’s (FDIC) coffers following last year’s collapse of Silicon Valley Bank and Signature Financial. U.S. Bancorp and Citizens Financial Group released the following fourth-quarter results:

• U.S. Bancorp’s earnings dropped y/y from $925 million, or $0.57 a share, to $847 million, or $0.49 cents a share. After stripping out one-time expenses, the bank’s $0.99 earnings per share (EPS) declined from $1.20 in the year-ago quarter and met the analyst consensus expectation. One-time expenses included a $734 million FDIC fee and a $171 million fee associated with the company’s acquisition of MUFG Union Bank. Separately, the company’s non-performing loans increased y/y from $972 million to $1.449 billion, driven primarily by a $421 million increase in bad commercial mortgages. At a time when households are turning to the safety of the nation’s largest banks, U.S. Bankcorp’s total deposits increased y/y from $462,384 to $502,782. On a positive note, losses for balance sheet optimization, including the sale of long-duration bonds that are susceptible to interest rate changes, declined y/y from $399 million to $118 million. The bank’s net revenues of $6.76 billion for the year climbed from $6.36 billion in the year-ago quarter, driven largely from an increase in noninterest income. Shares are down 1.5% on the news.
• Citizens Financial’s fourth-quarter net income of $189 million, or $0.34 a share, fell y/y from $653 million, a result of a one-time $225 million FDIC payment and an additional $120 million in other expenses, including laying off 650 employees. Analysts anticipated an EPS of $0.60. Its fourth-quarter revenue of $2 billion dropped approximately 10% y/y, but narrowly exceeded the analyst consensus expectation. The bank says it is seeing less pressure on its deposit costs and its fees are starting to rebound. However, the bank’s provision for credit losses increased y/y from $132 million to $171 million. Its fourth quarter revenue of $1.98 billion dropped y/y from $2.20 billion and missed the analyst consensus expectation of $2 billion. Most of the decline was a result of lower net-interest income. Shares are up 1.3% on the news.

Markets Move Lower

Hawkish remarks from Lagarde, coupled with stronger-than-expected economic data from the US and UK, are driving yields and the dollar higher, while simultaneously exerting downward pressure on stocks. Major US equity indices are experiencing declines, with the Nasdaq Composite and the Russell 2000 leading the way with declines of 1%. The S&P 500 and Dow Jones Industrial indices are down by 0.5% and 0.1%, respectively. Across sectors, there is widespread negative movement, except for the defensive health care and consumer staples sectors, which have each gained 0.2%. Real estate, consumer discretionary, and technology sectors are leading the move to the downside, with price declines of 1.2%, 1.1%, and 1%. Bond yields are on the rise, particularly at the short-end, with the 2-year and 10-year Treasurys trading at 4.36% and 4.11%. The instruments have seen an increase of 14 and 4 basis points (bps) during the session. Loftier yields are bolstering the dollar, with the greenback’s index up by 23 bps to 103.56. The US currency is gaining ground against most developed market peers, including the euro, franc, yen, yuan, and Aussie and Canadian dollars, while declining slightly relative to the pound sterling. Crude oil has reversed earlier losses and is now experiencing gains due to shifts in positioning, with bullish investors defending the $70 level. WTI crude is up by 0.4%, or $0.28, reaching $72.08 per barrel.

Investors’ Expectations Challenge Market

As earnings season continues, investors will need to consider their interest rate outlook alongside financial results. Robust pricing power and profitability are likely to lead to persistent inflationary pressures, which will incrementally delay rate cuts. Weaker earnings trends on the other hand, may lay the groundwork for monetary policy easing, but at the cost of deteriorating corporate fundamentals. The current projections of strong earnings growth and expectations of six rate cuts in 2024 creates an increasingly narrow path, especially on the back of Lagarde and Waller comments expressing caution and patience. I’m expecting yields to continue moving higher against the backdrop of sticky inflation, geopolitical tensions and heightened Treasury issuance. 

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