Stocks have powered firmly higher this year, with the S&P 500 printing a series of record highs and closely matching gains for the tech-focused Nasdaq, even as traders continue to discount the chance of a spring interest rate cut from the Federal Reserve.
Outsized gains for the chip sector, driven partly by the $1 trillion rally in Nvidia (NVDA) , have supported much of the market's rally, but the S&P 500 equal-weight index is still up more than 4.3% for the year, suggesting investors are seeing strength beyond the tech sector.
The broader advances have also defied a long series of official data, from jobs gains to inflation pressures to broader economic growth, that suggest the Federal Reserve is unlikely to deliver on its former forecast of three rate cuts for this year.
That's largely left the bond market to pick up the slack, at least in terms of projecting the Fed's likely rate path, as Chairman Jerome Powell and his colleagues prepare for their two-day policy meeting starting tomorrow in Washington.
“We’re waiting to become more confident that inflation is moving sustainably at 2%,” Powell told lawmakers on the Senate Banking Committee last week. “When we do get that confidence, and we’re not far from it, it’ll be appropriate to begin to dial back the level of restriction.”
Benchmark 10-year Treasury note yields, however, are trading at the highest levels in more than a month, following on from last week's 20 basis point jump, and were last changing hands at 4.332%.
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Treasury bond yields, which move in the opposite direction of prices, often rise in concert with higher inflation expectations. Investors sell bonds due to concern that inflation will erode the value of future coupon and principal payments.
Bond-market whispers
That certainly seemed a factor in last week's sale of $117 billion in new bonds from the Treasury, including a $39 billion auction of benchmark 10-year notes, which drew muted interest from foreign investors and a overall decline in demand from domestic investors.
Benchmark 2-year notes, the most-sensitive to interest rate changes, have risen around 12 basis points in the past month to 4.734%, in a move that suggests the Fed will likely maintain its current lending rate deeper in the summer months.
The CME Group's FedWatch, in fact, pegs the chances of June rate cut at just 56%, having priced in more than a 70% chance in early February, and expects no action from the Fed this week or in May.
The reasons are fairly straightforward but have been largely ignored by the stock market: Inflation is proving stubbornly difficult to return to the Fed's 2% target. It ticked modestly higher last month as rent and food prices continued to rise.
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"While inflation has softened considerably, it may take longer than expected to reach the Fed's target," said Glen Smith, chief investment officer at GDS Wealth Management in Flower Mound, Texas.
"We expect the Federal Reserve to start cutting interest rates in June, but a lot can happen in three months when it comes to the economy, and even the slightest reacceleration of inflation can push the Federal Reserve to stand down on rate cuts and revisit them towards the end of 2024," he added.
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The economy, meanwhile, is growing at a 2.3% clip, having expanded 3.2% over the final months of last year and 4.9% over the three months ended in October.
Retail sales are also on the mend, rebounding from January's post-holiday lull to rise 0.6% a collective total of $700.7 billion. The closely tracked control-group number, which feeds into the government's GDP calculations, has held steady at 0.4% for the past three months.
Job-market resilience
The labor market has been impressive as well, with just over half a million jobs created over the first two months of the yea, while the headline unemployment rate has extended its longest streak of less than 4% since the Vietnam War.
Rate traders are now expecting the federal funds rate, which currently sits at 5.25% to 5.5%, to end the year at around 4.7%, which is the highest projection since October of last year.
That puts the market, as well as the Fed, at least roughly in line in terms of anticipated rate cuts for the first time since stocks began their late-autumn rally last year.
Much could change, however, if the Fed's new quarterly Summary of Economic Projections, better-known as the dot plots, alters its current rate forecast.
"No one expects a rate cut on Wednesday, but after last week’s double dose of hot inflation data, everyone will be wondering whether the Fed is rethinking a June cut," said Chris Larkin, managing director at E-Trade From Morgan Stanley.
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"The S&P 500 just posted back-to-back weekly losses for the first time since October, but it also hit a record high for the ninth week in a row," he noted. "To continue that streak, the market will need to like what it sees in the Fed’s statement on Wednesday, and get confirmation from Jerome Powell that two months of sticky inflation numbers won’t derail the Fed’s game plan."
LPL Financial's Quincy Krosby also sees a market that is "overbought by many metrics" searching for clues from the Fed chairman, as bond markets continue to flash concern about springtime cuts. Ten-year notes are drawing a "line in the sand" at 4.3%, she said.
"The Fed meeting could determine the direction for the market, particularly if the Fed telegraphs that rates need to remain steady, even for just a bit longer," Krosby said. "That could be what's needed to allow this market to absorb gains and consolidate before the new earnings season begins."
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