For those of you who would prefer to listen:
After April brought showers to the Stock Market, sliding more than 4%, the first week of May brought flowers with Markets rallying nearly 2% to start the month. Volatility has certainly picked up and I’ll get into the why.
I can’t recall a busier week of market-moving key economic reports, Central Bank news-driven flow, fiscal announcements, and earnings all being released in a 5-day period.
Monday we started with the updated Treasury borrowing needs estimate for the 2nd quarter, which was revised up to $243 Billion from $202 Billion. The US Treasury cited lower cash receipts as the reason for the bigger borrowing estimate. The Congressional Budget Office is still forecasting $4.7 Trillion in tax receipts for ’24, and with the Treasury borrowing update it puts our federal fiscal year ’24 deficit of about $1.7-$1.8 Billion. That’s a lot of Bonds to issue.
The Bond Market wasn’t a big fan of more supply being needed and rates moved up on the news. The benchmark 2-year Treasury yield started pushing back near 5% on the news. For perspective the 2-year Treasury yields started the year at 4.25%.
Tuesday and Wednesday came with some more key Macro economic data. Employment labor costs rose 1.2% for the quarter, which puts the annual run rate at a hot 4.8%. This is a problem for the Fed and inflation as employment wages are highly correlated to inflation.
US manufacturing PMI’s came in next at 49.2 for April below the 50 level that denotes expansion vs contraction level. Manufacturing had been in contraction for 16 straight months until March, where it moved slightly above 50 to 50.3. So this April report refuted the trend of expansion.
More importantly, the prices paid component in this Manufacturing report jumped to 60.90, the highest level dating all the way back to August of ’22. That was when inflation (CPI) was well over 6%, it sits around 3.8% today. The Bond Market took this as rates needing to stay higher for longer and pushed the 2-year Treasury through 5% and got to as high as 5.04%.
Consumer confidence came out with the headline tumbling a surprising -6.1 points month-over-month. This slide was propelled by consumer expectations falling to a new low of 66.4. The consumer is telling us consistent higher inflation and higher rates are biting. In fact, confidence fell across all age and all income cohorts in April for the first time in a long while.
McDonald’s and Starbucks both reported this week with much bigger slowdowns in traffic and sales growth than anticipated. These are two companies that have raised prices more significantly than others. Those higher prices are starting to cause a slowdown in consumption. The consumer is having a harder time justifying over $6 for a Big Mac and $5 for a Latte.
Anybody remember the famous “off the express way, over the river, off the billboards, nothing but net” Michael Jordan vs Larry Bird Big Mac bet commercial? A Big Mac was around $2.20 back then, today it’s pushing $6, that’s 150+% higher, compared to the rate of inflation in the US being up closer to 100% during that same time.
The middle class is the most pivotal class when it comes to consumer spending and the overall Economy. The middle class is defined as those with incomes between $60k – $95k. In fact, they’ve shown a nearly 80% correlation to real consumer spending. Their real net worth likely accelerated in Q1, an incremental support for spending. However, high-interest costs and rising delinquencies should limit any “wealth effect” boost to consumption from this group.
So where are they still spending? Travel, hotels… think experiences. We got some earnings reports from cruise lines and Las Vegas hotels this week. Cruises reported record ticket pricing, consumer spending onboard and pre-cruise purchases, which are all exceeding prior years. Vegas room rates, bookings and gaming revenues continue to move higher, and are expected to continue to increase through the rest of ’24.
Are the expensive Lattes and Burgers a one-off isolated situation? The consumption in services says that’s the case right now.
Moving on from Big Macs to iMacs, Apple reported a slowdown in iPhone and iPad sales, while Mac wearables and services were all above expectations. The consumer is still spending an enormous amount of money in Apple’s ecosystem, just not as much as last year. Although revenues slowed from $94 Billion a year go to $90 Billion, they continue to generate huge sums of cash-flow. $23 Billion in fact. What are they doing with all that cash? Apple announced an increased dividend and a record $110 Billion stock buyback program. According to our math, the $110 Billion will retire approximately 594 Million shares over the coming year or approximately 3.8% of the entire float (shares outstanding). This is how Apple is able to keep its earnings flat to up (less shares in circulation with these monster buybacks). The Market rewarded Apple on the effort.
Oh, by the way, there was a Fed meeting and a jobs report this week as well. The Federal Reserve kept interest rates steady at 5.25-5.50%, while slowing the pace of balanced sheet runoff from $60 Billion a month down to $25 Billion, which was a bit larger and sooner than expected. Remember the opening where the US Treasury has to issue more debt than expected, that’s put pressure on rates and some illiquidity in the Bond Market, so our feeling here is the Fed is trying to ease some of the pressure with this move.
The Fed reiterated that the balance of policy leans toward interest rate cuts vs hikes. In fact, Powell said, “It is unlikely that the next policy move will be a rate hike.” The Fed clearly noted their lack of progress toward the 2% inflation goal as inflation has ticked up the past 3 months. The reason for keeping rates steady was that “inflation is still too high. Further progress in bringing it down is not yet assured, and the path forward is uncertain.” Powell articulated that enough Labor Market deterioration is when they’d entertain cutting interest rates.
Powell stated their base case is still for inflation to move back down over the course of the year, though his “confidence in that is lower than it was because of the recent data.” This about sums it up: a bit stuck at the moment. They keep rates higher for longer, and in ‘restrictive territory,’ they run the risk of an economic slowdown potentially coming quicker. This would bring down inflation, but have a more meaningful and longer slowdown in the Economy. However, with inflation remaining stubbornly sticky, if they cut interest rates too early, they run the risk of reigniting inflation and it becoming more ingrained and much longer-lasting, thus crushing the low and middle classes further.
The battle continues as the former decision (higher for longer) helps the lower and middle class, who have been hurt most by consistently higher prices over the past few years. Fighting inflation is of the utmost importance to those groups. The latter decision (easing too early and reigniting inflation) helps the upper class that owns assets and has some slack in their income vs spending. The easy money policy the US has run monetarily and fiscally since the Financial Crisis has created this huge bifurcation amongst income classes, and the Economy is not showing any signs of easing this dilemma currently.
Friday morning saw the monthly non-farm payroll report, which saw 175k jobs created vs the expected 240k. This is the first miss in quite some time. So after the early week saw interest rates rising on the back of higher Treasury issuance and higher-than-expected inflation data, this weaker jobs report created the opposite effect. Interest rates across the Treasury curve fell on the potentially softening Labor Market report and the anticipation of a Fed rate hike brought forward. Remember that 2-year yield above 5% earlier in the week? It’s back down to 4.80% to close the week.
Why all the volatility of late? Simply put, the mixed messages from all this economic data, Fed-speak, earnings, and Market pricing.
Here is an example of these extreme moves of late: On Tuesday, rate hikes were fully priced for December, i.e., higher for longer, and no major cuts are coming soon. Remember, entering the year, the Market was pricing in 5-6 rate cuts by year-end ’24. By Wednesday, rate cut pricing moved up to November, and by Thursday, November was fully priced in. Today, due to the Jobs miss, cuts moved all the way back up to September. These moves are abnormal and speak to the uncertainty regarding the current economic path. We will continue to track things closely and keep you informed.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike Harris
