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May 2024 Market Commentary

May 16, 2024
  • Inflation data suggests that progress towards the Fed’s longer-term 2% target has stalled and could even be at risk of reaccelerating.
  • Market expectations for Fed rate cuts fell from three to one as investors brace for the possibility that rates will remain “higher for longer.”
  • 1Q24 GDP growth of 1.6% is the weakest since 2Q22.
  • Returns: S&P 500 -4.2%.
  • Bloomberg US Aggregate Bond Index -2.5%.

According to an old mistaken belief, ostriches put their head in the sand when faced with danger. While that is not actually true, the idea has persisted and today the saying to put, or have, your head in the sand, according to the Cambridge Dictionary, means to refuse “to think about unpleasant facts, although they will have an influence on your situation.”

During the first quarter, investors arguably put their head in the sand with respect to mounting evidence that inflation was not, as the Fed suggested, moving “sustainably” back down to the Fed’s longer-term 2% target. Ignoring the lack of further improvement in inflation and the implications for monetary policy, investors pushed equity prices higher resulting in the S&P 500 gaining 10%, marking its strongest start to a year since 1Q19.

In April, upon lifting their heads from the sand, investors were vexed to find declines in inflation effectively stalled. Data released during the month highlighted the problem. After witnessing a sharp deceleration in inflation in the second half of 2022 and into 2023, further progress in 2024 has been scant. As measured by the consumer price index (CPI), March inflation rose 0.4% from February, tied for its fastest pace since September, and 3.5% from a year ago, also its fastest pace since September. Excluding food and energy prices, core CPI, rose 3.8% from a year ago, unchanged from February’s pace. Within the CPI data, “Super Core” inflation which builds on core inflation by removing housing prices, jumped from 4.3% in February to 4.8% in March, its fastest pace in 11 months.

Separately, the Fed’s preferred measure of inflation, the personal consumption expenditures (PCE) index effectively corroborated the CPI data. On a monthly basis, core PCE rose 0.3% in March, unchanged from February, and 2.8% from a year earlier, also unchanged from February. The results reinforced the narrative that further progress towards the Fed’s 2% target will likely be slow and uneven.

Concerned by the inflation data, talk of rates remaining “higher for longer” resurfaced as investors curtailed their expectations for Fed rate cuts in 2024, from three at the start of the month to one by the end of the month, while pushing out the timing of the first hike from June to November. In addition to lowered expectations, talk that the Fed might not cut at all in 2024, or that its next policy actions might be a hike instead of a cut, began to emerge. Those fears gained further credence after Minneapolis Fed President Neel Kashkari opined aloud that if inflation were to continue moving “sideways”, it would “make me question whether we need to do those rate cuts at all.”

The combination of disappointing inflation data, lowered rate cut expectations, a grudging acceptance that rates might remain “higher for longer” and a Fed President questioning the need for any rate cuts in 2024 helped push the S&P down over 5% through the first three weeks of the month. Markets rallied towards month end, somewhat paradoxically, after data showed US GDP grew just 1.6% in 1Q24, far below the consensus forecast, and the slowest pace of growth since 2Q22. Rather than being disappointed by the slowing growth, investors took a bad-news-is-good view of the data, hoping that it might convince the Fed to move forward with rates cuts sooner than later. A closer inspection of the data, however, suggested that might not necessarily be the case. Excluding the effects of inventory investment, government spending, and net exports, categories which tend to be more volatile, private domestic final purchases, which provide a clearer picture of underlying demand, expanded 3.1%, roughly the same growth as seen in 2H23.

Though the weaker GDP data provided a reprieve to the selling pressure faced by markets earlier in the month, markets ultimately ended April in the red with large caps (S&P 500) declining 4.2%, while small caps (Russell 2000), which tend to be more sensitive to interest rates and the pace of economic activity fell 7.2%. International markets fared better with developed markets (MSCI EAFE) shedding just 2.9%, while emerging markets, which underperformed in the first quarter, eked out a small 0.3% gain.

Like equity markets, fixed income markets closed the month lower, with the Bloomberg US Aggregate (“Agg”) Bond index, the broadest measure of the US bond market, falling 2.5%. Higher rates were the primary culprit as both the 2- and 10-Year Treasury yields finished the month near, or above, highs last seen in mid-November.

Strong ISM manufacturing data kicked off April’s economic calendar, pushing yields higher as the economy continued to surprise to the upside. The prices-paid component within the ISM data was particularly worrisome, as it indicated resilient inflationary pressures. A robust March jobs report which saw the economy add 303K jobs, sparked further concern that the market was running too hot to keep inflation in check. As a result, investors pared back their assumptions for Fed rate cuts in 2024. That action was only reinforced with the release of CPI inflation data which showed a third consecutive higher-than-expected inflationary print. On the news, the 2- and 10-Year Treasury yields experienced their largest one-day increases in over a year.

Mid-month, Fed Chair Jay Powell conceded that given the recent data, policy makers would likely need to delay any interest rate cuts. He had been a steady proponent of possible cuts in 2024, so his turnabout led to another spike in yields. An upward revision to Q1 PCE inflation data in the final days of the month pulled yields slightly higher as did the Employment Cost Index which accelerated in Q1 to its fastest pace in more than a year. The month’s data provided a compelling case that progress against inflation has at least sputtered, and possibly reversed. As a result, assumptions for rate cuts in 2024 have been pared to just one, possibly to occur in November. The 2-year Treasury yield ended April at over 5%, a first in nearly six months. The 10-year Treasury yield saw its biggest monthly increase in over a year, rising nearly 50 basis points to close the month at 4.59%.

Municipal yields saw a similar trek higher on the month, though the rebound relative to last year’s highs has been muted. The rally in the municipal market to end 2023 was more aggressive than that seen in the Treasury market, so municipal yields remain further below last year’s highs on a relative basis. For perspective, the 2-year Treasury yield finished April at ~97% of its highs from last October, while the 2-year AAA Muni yield finished the month at ~87% of its October highs. Regarding 10-year bonds, the 10-year Treasury yield ended April at ~94% of its October its highs, while the 10-year AAA Muni yield finished the month at just 77% of its recent highs. Strong demand has helped support muni bond prices, thereby preventing yields from returning to 4Q23 levels.


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