Unlock Editor’s Digest for free
Roula Khalaf, editor of the FT, picks her favorite stories in this weekly newsletter.
The topsy-turvy US economic data released this week sent markets into distress, but still just out of the danger zone.
Official figures showed Thursday that the U.S. economy wasn’t necessarily ahead of the rest of the developed world as expected. It found that growth in the first quarter was at an annual rate of 1.6 percent – far behind the 3.4 percent in the fourth quarter of last year and well below the 2.5 percent that economists had expected.
In response, benchmark government bond prices rose for a brief moment – a typical response to a severe growth shock.
But other data, particularly on inflation, muddied the picture. On Friday, the Federal Reserve’s key measure of price fluctuations – personal consumption spending – showed a slight increase to 2.7 percent in the year to March, well ahead of forecasts and above the previous month.
For months, holdouts have been hoping that the Fed will cut interest rates aggressively and soon, drawing comfort from the relatively calm PCE inflation data and trying to ignore the encouragingly strong readings of other measures. Figures like those from Friday clearly underline that developments are not going in this direction. “No matter how you look at the numbers, it’s clearly not the kind of inflation dynamic that would allow the Fed to easily cut rates,” noted Deutsche Bank’s Jim Reid.
The result is that bond prices have fallen again and benchmark 10-year bond yields are back to November levels, a little below 4.7 percent, as if all the hassle surrounding expected interest rate cuts in late 2023 and beyond was over This year everything was a strange dream. Let’s never talk about it again.
The big winners here are the macro hedge funds, which have bet on few or no interest rate cuts from the Fed this year and an associated rise in bond yields. I’m sure we’ll all be happy when the downtrodden billionaires get a windfall.
For the rest of us, humble mere mortals, this combination of slower growth and painful inflation is a troubling mix.
Bond markets have already struggled to cope with the death of the rate-cutting trade. “Fixed income didn’t get the joke,” said Michael Kelly, global head of multi-asset at PineBridge Investments. “It’s an earthquake.”
Stocks, meanwhile, can easily absorb this as long as higher interest rates are the result of a stronger economy, he said, and as long as investors are confident that the next interest rate move, whenever it comes, will be a cut. “I really don’t think the stock market is going to fall out of bed as long as the forecast is going down and not up,” he said.
However, given the latest data, it’s a little harder to be sure on both fronts, which is why there was a sharp drop in stock prices on Thursday, saved only by positive results from Alphabet and Microsoft.
An increase in US interest rates this year remains a long way off. But it’s still a prospect that some investors are taking increasingly seriously. To put it mildly, “That would really be a problem for the stock market,” said Robert Alster, chief investment officer at Close Brothers Asset Management.
At the moment, market sentiment is a bit gloomy, largely because persistently high inflation has surprised even smart economists. But unlike last fall, when the idea that interest rates would last longer really took hold, things are quiet. Some investors are even excited about the chance to invest in more stocks after a rare recent price drop. The key to what could bring about this change is the number five.
Round numbers shouldn’t matter in markets, but the reality is that they do, and as the benchmark 10-year Treasury yield climbs toward 5 percent, the noise gets louder.
If you remember October, approaching and reaching this point triggers a moment of panic about the really big questions. Who buys all the US government bonds? How does the world’s largest superpower finance itself? Will the dollar remain the most important global reserve currency?
As always, the answers to these questions were: 1: anyone, just at a lower price; 2: see 1; and 3: yes. But it is never a pleasant experience when such debates take place.
The current adjustment in bond yields is different from last year. Inflation is higher than desired, but significantly lower. But when yields reach such remarkable highs, the question becomes sharper about whether it’s really worth buying stocks when you can get those returns with risk-free bonds. At the same time, gold fans and financial crisis enthusiasts are shying away and putting a stop to the general enthusiasm for risky investments.
Investing is never as easy as “big numbers, sell everything.” But when the mood is nervous, these mind games can have a real impact.
“Five is a really good number,” said Alster of Close Brothers. “As long as we are below five and the inflation data does not worsen. . . We can convince ourselves that the next step fails and I think we’ll be OK.”