After an incredibly strong six-month run that began last October, the upward trajectory in financial markets has come to an abrupt halt. It was a tough week, with declines across equities, fixed income, and even oil. There is little doubt that the headline-grabbing turmoil in the Middle East has spooked some market participants. However, that seems to be stealing the thunder of a much larger undercurrent of changing interest rate expectations.
Earlier this week, during a Canadian economic forum in Washington, D.C. (odd, right?), Federal Reserve Chair Jerome Powell participated in a panel discussion. During his remarks, it was clear a shift in messaging was underway. It was the first time he had admitted publicly that the Fed members were not seeing what they wanted from the inflation reports:
“The recent data have clearly not given us greater confidence and instead indicate that it’s likely to take longer than expected to achieve that confidence.”
“Twelve-month core [personal consumption expenditures] inflation, which is one of the most important things we look at, is estimated to have been little changed in March over February at 2.8%, and the three- and six-month measures of inflation are actually above that level.“
These remarks contrast with previous statements, in which he continued to state that they would not overreact to one reading, that they’re continuing to see disinflation trends, etc.
So, how have the hotter-than-expected inflation reports and changing narratives impacted interest rate expectations over the last three and half months? Let’s review three charts that help tell the story.
The first chart shows the forward-looking market expectations for the Fed Funds rate from three dates. The magnitude of the move is remarkable, with January 2025 expectations now 120 basis points higher than at the end of 2023.
The second chart shows how expectations have changed over time for three points on the curve (June, September, and December). Each CPI data release is marked, and it is clear the majority have been catalysts for increased rate expectations.
Lastly, the third chart shows the number of rate cuts the market was expecting by month. Since the end of December, market participants have priced out five rate cuts, dropping the expectation of seven cuts down to two.
In hindsight, the initial euphoria of the “Fed Pivot” had the market expecting too much too soon. With the tougher inflation numbers and the continued pressure from world events, interest rates will stay higher for longer, at least for now.
And while these are dramatic changes in anticipated interest rates over a very short time, with the consensus that rates will stay high, a correction of this magnitude is not unusual. The good news is that the consumer still looks strong, and the employment picture is solid. If that persists, it should keep the overall economy moving forward.
Economy
- It was another rough week across all financial markets as Fed comments and turmoil in the Middle East spooked investors. The S&P 500 was down -3.0%, the Nasdaq was down -5.5%, and the small-cap Russell 2000 was down -2.8%.
- Retail sales in the U.S. rose 0.7% MoM in March, following an upwardly revised 0.9% gain in February and much higher than forecasts of 0.3%, suggesting consumer spending remains robust.
- Building permits in the U.S. fell by 4.3% to a seasonally adjusted annual rate of 1.46 million in March, falling short of market expectations of 1.51 million. Permits have reached their lowest level since July last year.
Stocks
- U.S. equities were in negative territory. Technology and Consumer Discretionary led the decline, while Utilities and Consumer Staples outperformed. Value stocks led growth stocks, and small caps beat large caps.
- International equities closed lower for the week. Developed markets fared better than emerging markets.
Bonds
- The 10-year Treasury bond yield increased 12 basis points to 4.62% during the week.
- Global bond markets were in negative territory this week.
- Government bonds led for the week, followed by high-yield bonds and corporate bonds.
