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The ‘2 or 3’ Cut Debate Heats Up

Published 04/03/2024, 02:50 AM
Updated 07/09/2023, 06:31 AM

Mood was down in Asia today as the strongest earthquake in 25 years led to halted operations in TSM and United Microelectronics (NYSE:UMC).

Elsewhere, major stock and bond markets in Europe and the US were painted in the red yesterday as well; rising oil and commodity prices fueled inflation expectations while further strength in the US economic data boosted worries that the Federal Reserve (Fed) may not cut the interest rates as much as wished this year. Yesterday’s data showed faster-than-expected recovery in factory orders, though job openings fell more than expected.

The market now prices less than three rate cuts from the Fed this year, below the three rate cuts plotted by the Fed members at last month’s FOMC meeting. And even though Fed’s Mary Daly and Loretta Mester said that three rate cuts look appropriate this year – God knows why – Mester added that ‘it’s a close call’ on whether fewer rate cuts will be needed. She was certainly referring to robust economic data and up-ticking inflation!

The US 2-year yield extended to 4.73% yesterday, the 10-year yield spiked to 4.40%, the S&P 500 tipped a toe below the 5200 level but managed to close above this psychological mark. Nasdaq closed near 1% lower and volatility rose. The US Dollar Index however retreated despite the positive pressure on yields.

Today, investors have their eyes set on the ISM non-manufacturing index and the latest ADP data. The US economy is expected to have added nearly 150K new private jobs in March. Friday’s jobs data should split hairs between those anticipating three rate cuts and those banking on just two. A strong set of jobs figures – that would add more spice to strong US growth and picking inflation - should further soften the Fed doves’ hand, weigh on equity and bond valuations and keep the US dollar sustained against most majors, starting with the euro.

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The EUR/USD rebounded before hitting 1.0740 yesterday as the US dollar fell sharply despite supportive economic data. But the data released in Europe confirmed that inflation in Germany cooled for a third straight month and today’s aggregate Eurozone inflation is expected to show further easing. The headline inflation is expected to ease from 2.6% to 2.5% and core inflation from 3.1% to 3%.

Unlike the strong US growth and rising US inflation since the start of the year, the persistent slowdown in European inflation and gloomy Eurozone economies justify a European Central Bank (ECB) rate cut and should continue to weigh on the EUR/USD. Across the Channel, Cable saw support near 1.2550 on a broadly softer US dollar, but the data fueled the Bank of England (BoE) rate cut hopes: inflation in British stores dropped to the lowest level in more than two years.

Overall, the US is isolated on an island with surprisingly strong economic data and rising inflation. But the dollar inflation could easily spill over to the rest of the world if the US dollar gained strength backed by a significant retreat in dovish Fed expectations.

FTSE 100 in a good place to catch up with the rest of Western indices

The FTSE 100 benefited from rising oil & commodity prices and softer sterling to extend gains past the 8000p psychological mark. The FTSE 100 will likely see more tailwinds if oil and commodity prices pick up momentum and the British blue-chip index could be a good hedge against rising inflation worries.

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Across the Atlantic, the moodiness in US stocks since the quarter started is mostly due to a retreat in Fed expectations because of strong data, but note that strong economy per se is not a reason to be sad about. This is why the S&P 500 could temper the significant retreat in Fed cut expectations since the start of the year. If the US earnings continue to satisfy, the US stock markets may avoid a significant meltdown.

Oops

Tesla (NASDAQ:TSLA) released the first quarter deliveries report yesterday and the numbers were hard to swallow. Analysts were expecting around 6% drop in deliveries last quarter compared to a year earlier, but the deliveries fell 8.5%. Inventories rose and the inventory build-up will be another major headwind to the cashflow. As such, Tesla closed the session almost 5% lower and will hardly reverse losses when the 50% annual sales growth narrative continues to fade away. Tesla’s PE ratio is still around 63 giving it a large room for extending losses.

Elsewhere, Rivian (NASDAQ:RIVN) built and sold more EVs than expected but shares plunged more than 5% on overall gloomy outlook for the EV sector.

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