Previewing the Fed Meeting and CPI

Jeff Buchbinder:

Hello everyone, and welcome to the latest SMN Market Signals podcast. Your host for this week, Jeff Buchbinder, here with my friend and colleague Lawrence Gillum. Here to talk a little fixed income. How are you today, Lawrence?

Lawrence Gillum:

Oh, I'm doing great, Jeff. It's Fed week. How could I not be great?

Jeff Buchbinder:

Oh, you've got to be really jazzed up because yes, indeed. It is Fed week and CPI week. That's right. Which normally would say that bond folks get more excited about CPI than equity folks, but that might be a little bit of a stretch given the environment we're in, where it seems that all anybody cares about is inflation or Nvidia or maybe GameStop. So, let's roll. And, of course, here's your disclaimers. It is Monday, June 10, 2024 as we're recording this early afternoon. Markets are not really moving a whole lot today. Kind of waiting for all the events of the week to unfold. Here's our agenda. We're going to start by recapping the market action last week, which we, of course, always do. We'll talk about the jobs report, you know, try to give you some insight a little bit beyond just the numbers.

Jeff Buchbinder:

Then Lawrence will talk about what to expect from the Fed this week, and we'll preview the rest of the economic calendar. But it's not just economic calendar. There's actually some company news this week that's really interesting. So speaking of interesting, we had a lot of political volatility last week, which has caused markets to move around a little bit more, international markets than domestic markets. So that's, I guess you could say one theme of this podcast today. We'll get to that in a minute. Here's chart of the S&P 500. And I think what's interesting here to point out is that breadth has not been as strong in this latest run to record highs as it was in the last run. So we actually think it is a pretty reasonable expectation to think that we will pull back off of these latest highs, which came on Wednesday of last week before we faded a little bit into the end of the week.

Jeff Buchbinder:

Still ended up with solid gains for the week for the S&P 500. But we're back to that environment where it's kind of narrow. You can see that in the middle panel here, the percentage of stocks hitting new 52-week highs as the market hit new 52-week highs was pretty low here. It's actually under 5%. And, you know, that's quite a bit below what we've gotten used to in recent months. So here's the inter-market. I'll do equities, then I'll hand it over to Lawrence for the fixed income side. It was all about tech. I didn't go back and look at this historically, but this is one of the biggest growth-over-value weeks that I have ever seen.

Jeff Buchbinder:

You see here, growth index, at least for the Russell 200, the mega cap growth index up 3.1%. Mega cap value down 0.3%. So why did we see that? We saw that because tech was up almost 4. A lot of that was certainly Nvidia which has split its stock, I guess, over the weekend. And then, you know, we had good earnings from CrowdStrike. We had good earnings from Hewlett Packard Enterprises. Certainly tied to the AI data center boom. And there you go. Big, big week for tech. There's certainly some tech and comm services and consumer discretionary, so we saw solid gains there. And then on the other side, you know, energy was down 3% despite natural gas prices rising sharply. And utilities down almost 4%. You know, some of these utility plays on AI power demand, in particular Constellation and Vista, have come down, at least on Friday, came down.

Jeff Buchbinder:

So I think we're just sort of taking a little bit of the froth out of some of the AI names in utilities is really all that we did. Although the stocks are bouncing back nicely here this morning. Internationally, of course, we had the Mexican election, so that weighed on that market. The surprising result there, which was worrying to markets that that economy will move too far or that regime will move too far left. And then we had the Indian elections. The market took that much better. I'll get to that in a minute. You actually had solid gains in India. Otherwise, you know, not particularly good or bad in international. Kind of all in a sort of tight range. So how about the bond market, Lawrence? I thought the reaction to the jobs report was really interesting. You know, the lead up to the jobs report was really interesting too. Help make sense of the bond market performance last week, because people who just paid attention Friday might be surprised that bonds were up.

Lawrence Gillum:

Yeah, no. It was a pretty volatile week last week. It was on pace to be a really good week until that job report came out on Friday. Looking at just individual rate movements over the course of the past week, we had the 10-year Treasury yield fall by 11 basis points where 0.11% on Monday, which really started that rally off and kicked that rally off in the rates market and the fixed income markets. But then we saw a 14 basis point increase in yields, so 0.14% increase in yields on Friday. So net, we were up only about 0.4% last week, despite all the volatility that took place over the past week. The performance was largely across the board. Mortgage-backed securities, which is our preferred expression within the core fixed income markets, up about 0.6%.

Lawrence Gillum:

Treasury is up about 0.4%. And then investment grade corporates also up about 0.4%. So we did see some outperformance on these triple-eight-rated agency mortgage-backed securities, which we still like. They're underperforming generally this year, but we do think that as the Fed reaction function continues to play out throughout the rest of this year, we should get some outperformance in that market. Kind of switching gears to plus sectors. Plus sectors had a good week led by Munis. High yield munis were up 1.3% last week followed closely behind the National Muni Index, up 1.1%. So after underperforming over the past call it month or so Munis did rally back, which is something that we like to see. We're big fans of munis here in LPL Research.

Lawrence Gillum:

Looking at preferred securities. Preferred securities are our preferred expression within the plus sectors. Up about 0.3% on the week, up about 4.7% year to date, and up over 11% over the past year. So that market has done really well and that trade in our portfolios has done really well relative to a lot of these other fixed income sectors that we're allocated to. So volatile week but at the end of the week, you wouldn't have known it if you just woke up on, like, to your point on a Friday and saw yields higher but we did end up positive for the week, which is good to see.

Jeff Buchbinder:

Yeah. So, you know, it hasn't been a great year for munis, but, you know, better than a lot of other categories in fixed income. And then when you add the tax advantages, maybe it has been a pretty darn good year. So don't forget about your munis, especially for folks in the high-tax states. So thanks for that, Lawrence. The, you know, commodities were interesting. I mentioned the natural gas spike. You know, natural gas is a little bit of an AI play just because you've got, you know, you've got to power the grid. So, you know, you saw a pretty big balance there, even though oil didn't really do anything last week. Remember, OPEC+ announced they're going to ease their production cuts over the balance of the year. So that really made kind of oil stuck in the mud, I guess.

Jeff Buchbinder:

Precious metals were interesting. Big drop there. You know, that's not an area that LPL Research has been too excited about. But we have had, you know, pretty nice chart formations. You know, gold has made a number of all-time highs this year. So, you know, the sharp drop there appears to be, at least in part, related to the strong dollar. Remember, precious metals and the dollar tend to move in opposite directions. But certainly there's still support from geopolitical tensions. There's still support from political uncertainty. So, you know, wouldn't call us bearish but, you know, kind of more, you know, neutral to positive with maybe keeping a close eye on them. And then, of course, we're continuing to watch the yen. It's not quite to where you would think that the Bank of Japan and the Japanese government would intervene again, 157, but we're getting close, so we'll see.

Jeff Buchbinder:

Keep watching the yen. I still like Japan as an international market to invest in. So let's go to the jobs report now. Obviously, this ties closely to the Fed. Obviously, ties closely to the upcoming CPI report. I mean, we were really set up if we got a better jobs report to potentially get yields down quite a bit. I mean, we're still, you know, down what, 25 basis points from recent highs. But, of course, that jobs report got in the way by being a little bit too strong. But there are a couple positive stories, you know, within all the jobs numbers that we got. We got more than just the jobs report on Friday. We also got job openings and labor turnover, and we got the ADP report. This chart shows you the flows into the labor force. Right?

Jeff Buchbinder:

So, in other words, people that move from not in the labor force, so they're not looking for work, they don't have a job, and then they essentially reclassify into the unemployed and looking for work category. Right? And so we've seen more of this. Obviously, it makes sense, we would see this after the pandemic, but it started to pick up even in the last year or so and is on a continued uptrend. Immigration is a part of this story too. So why is this good news? It's good news because if you have a bigger labor supply, you're more likely to be able to keep wage pressures down. Another way you can keep wage pressures down is with just taking job openings down. Okay? If there's too many openings and companies are fighting for labor and bidding up wages, you know, there's your inflation problem. But this has actually come down really nicely, and it's almost at pre-pandemic levels. As you know, Lawrence, Fed Chair Powell brought this up. Gosh. It's probably been more than a year ago now. This is considered to be a key ingredient for the soft landing if they can just, if this economy just takes openings down, but doesn't have to do much, you know, in the way of layoffs, there's your ingredient or key ingredients for a soft landing. What do you think?

Lawrence Gillum:

That's absolutely correct, and Chair Powell did mention that. Given the amount of openings to the unemployed back in, I guess it was early 2022, where we did see a spike in openings relative to the unemployed. So to see that kind of come back to normal is exactly what the Fed wanted to see. So there's really two channels you could argue that would impact the labor market. One is the amount of openings, and second to your point is the amount of layoffs. So the Fed wanted to be in an environment where layoffs were low and openings came down. And, I mean, this is exactly what they were hoping to see. Now, we did see the unemployment rate tick up a little bit. We're around 3.95% rounded up to 4%. So there was some mixed messages in that labor report. But by and large, this chart, I think is a good one for Fed watchers and for the Fed in particular.

Jeff Buchbinder:

Yeah. Maybe this keeps the market at expecting a cut or two, or at least part of that narrative, even though the you know, the job report isn't really telling us that the Fed should cut. Maybe the inflation data hasn't been convincingly telling us that the Fed should cut, but this, this is just one piece pointing in that direction. So there's a segue to you again, Lawrence. You know, I guess I mean, nobody expects the Fed to actually change rates. You know, probably not June, July, or maybe not even September. Right? But the market does move on, you know, Fed comments. It moves on the press conference. It moves on the SEP right? The Summary of Economic Projections are going to come out, the updated ones, and it can move on the dot plots. So there's our first chart for you. What should people be looking for in terms of the dot plots? I guess right now they're at three cuts, right?

Lawrence Gillum:

Yeah. That's absolutely right. And to your point, you're exactly right. No one is expecting a rate cut or a rate hike at this meeting. The markets are pricing in about 1.5 cuts this year, but what's going to be important from this Fed meeting is, again, not the statement. Not the, you know, fact that interest rates didn't change, but it is going to be the release of their Summary of Economic Projections including this dot plot that we're showing here. And, just as a reminder, the dot plot is a plot of the individual FOMC members and their expectation of where interest rates should be at the end of these years. It's not official policy. It's just kind of a best guess, if you will, by Fed officials. And what's important, a couple things that are important, markets have become overly negative in terms of the amount of rate cuts expected over the course of the next few years.

Lawrence Gillum:

If you look at this dot plot 2024 individual Fed officials, they leaned on three interest rate cuts this year. Markets, as I mentioned, have have priced in 1.5 cuts this year. So we're likely to see an adjustment on some of these dot plots and move higher, meaning fewer cuts. But what's going to be interesting is the amount or the number of cuts that are are expected in 2024 and 2025, we do expect those to kind of creep up a little bit relative to where they were back in March. So maybe the Fed is penciling in two rate cuts this year and maybe three cuts next year. But what's interesting is markets have already re-repriced for that. Right? So it would need to come as a pretty big surprise to get a meaningful move out of the rates market anyway. And we'll talk about kind of our expectation on the rates market in just a second.

Lawrence Gillum:

But given the overly negative pricing that's already taken place over the last few months, you know, a lot of the bad news we think has been priced in or baked in to yields already. So but there's always going to be that element of surprise if things change more than markets are expecting, you could see a sell-off in the rates market. But I would argue that a lot of the bad news is priced in already. Something else to keep an eye on though, is that longer-term column there. There's been a lot of discussion recently in the press about what the longer-term kind of neutral rate is, and just as a reminder, that neutral rate is the interest rate that is neither accommodative nor restrictive. It's just kind of is what it is. There's been a lot of discussion in the financial media press by the Fed officials suggesting that that longer-term interest rate needs to go higher. So that's something that we'll pay attention to and see if that does in fact go higher. That could have a marginal impact on Treasury yields. But again, given the sell-off that we've seen in rates particularly since, you know, early January we do think a lot of the bad news is already priced in.

Jeff Buchbinder:

Yeah. Just my unsophisticated fixed income hat tells me that if the dot plot goes to two cuts, that could actually, you know, be bullish for bonds. If it goes to one, you know, then that's maybe closer to the base case and maybe get a little bit of weakness, but not too much because like you said, the market's already there. The market's kind of been there for a little while. So you mentioned rates. Lawrence said, obviously it all comes down to rates. That's what really is going to matter for bonds and for stocks frankly. So if this news is priced in then, you know, is it possible that we actually see a bond market rally on this?

Lawrence Gillum:

On the Fed? Yeah. Yeah. It's certainly possible to your point. I mean, if the dot plot comes in and beneficial pencil in two rate cuts this year, given where current pricing is, we could see a little bit lower yields. Our base case is still that 375, 425 for the 10-year by year end. So we think that there's room for yields to fall, and we certainly think yields are going to fall or be lower than they are currently by the end of the year. But, absent any sort of financial crisis or any big geopolitical event out there, we think we're kind of in this range for the foreseeable future until later in the year when we get into that 375, 425 range given, kind of... It's going to depend on the inflation story, the labor market story.

Lawrence Gillum:

So, you know, maybe there's a cut in September. Maybe there's a cut in December. You know, whatever the case may be. We do think interest rates are coming, or interest rate cuts are coming, I should say. So it's a matter of when, not if. And, you know, once those rates become more, or those rate cuts become more definitive, we're likely to see lower yields. So, you know, I've talked about kind of being passed peak rates for this cycle. You know, 5% was probably the high for this cycle, so we're kind of in this range for now, but we do expect yields to move lower again, absent any sort of reaser resurgence in inflationary pressures.

Jeff Buchbinder:

We've digested a lot of Treasury auctions. I know we have more coming this week. So, you know, that's a good sign. Right? A lot of that, I mean, we have more to come, but the fact that a lot of that's behind us, and we're still in this kind of mid-fours range I think is encouraging. How about the ECB cut? Actually, and we got Canadian Bank of Canada cut as well. Do those have any impact you think on what we might hear from the Fed?

Lawrence Gillum:

Potentially. I think what we saw out of the ECB in particular was, well, I think it was classified as a hawkish cut. They kind of painted themselves in a corner there where they kind of had to cut, given market pricing on the expectation of rate cuts. There was like a 99.5% probability that they were going to cut. So if they disappointed, you could have seen a lot of volatility in markets. So they kind of forced themselves to cut despite the data not being as friendly as they were hoping for at this point. So I think that is something that the Fed is going to consider and pay attention to. But remember, the Fed usually leads the process in terms of rate cuts and rate hikes. So, they're going to do their own thing. And, you know, whether the other central banks follow or not, it's certainly up to them. But, yeah. I think it's really going to be about U.S. data and U.S. data alone.

Jeff Buchbinder:

Yeah. I think that's right. When ECB raises their inflation forecast while they cut rates, you know that... It's not something they really wanted to do. That was strange but, hey. I guess it's not the first strange central bank move out of Europe that we've ever seen. I certainly remember one, maybe 10 years ago, maybe longer. So let's switch gears. I'll just really quickly highlight the Weekly Market Commentary for this week from LPL Research, which is on India, and specifically the elections. And how, well, the initial reaction was certainly negative because it, you know, suggested it would be harder for Prime Minister Modi to, you know, to achieve his objectives, right? And continue his pro-growth policies, infrastructure development and all of that, attract foreign investment.

Jeff Buchbinder:

But it looks like he's cobbled together enough of a coalition that, you know, a government that he'll be able to to certainly continue to rule. And he might get a lot of this stuff done anyway. You have this dynamic. I mean, it's similar in a lot of places where you've got, you know, sort of the wealthy class, the wealthy elite, the billionaire class, you know, ruling and trying to create this business-friendly environment. But then you also have a really big income gap, right? And so Modi's going to have to move a little bit to the left, you know, a little bit more populist, I guess you could say, to try to, you know, keep the country as unified as possible. But it looks like, so the market's actually responded well to this.

Jeff Buchbinder:

You saw that on the previous table. And we still like India as an investment. This is through 2022. This is the latest data we have. This is India Foreign Direct Investment. And you can see there's a little bit of an uptrend over the last decade. I mean, it's not a strong uptrend. Maybe there's a little, you know, over investment in 2020 that had to be digested in 2021 and 2022, but it's an uptrend nonetheless. And this has been a focus for Modi. This is China. And you see it's much less of an uptrend if you had, we'll call it the Trump downturn in China investment in 2016, 2017. And then, you know, you had that spike. It was kind of out of necessity in 2021. And then, look what happened in 2022. It collapsed. And it's going to be weak again in 2023 when the numbers come out.

Jeff Buchbinder:

So India's pro-business. They're treating capital better and certainly the world is giving it more capital than China. And I don't have to tell our regular listeners about the environment in China not being as friendly as business-friendly and as welcoming for capital. So India's gaining share a better place to invest. India's pretty tech savvy. Certainly a lot of the investments are going into the tech sector. You see at the bottom of this, this is computer hardware, software and services. Just far above the investment in these other categories, trading, drugs, pharmaceuticals, autos, chemicals. So it's really a knowledge economy which positions it well for the future. It's another reason to be positive on the Indian equity markets within the emerging markets universe. And this is just another way to show that India's been gaining share on China, because India's stock market, which is in blue, is doing much better, has been doing much better than the Hong Kong market, which of course is where a lot of the leading China companies are trading. Done a lot better than the Hong Kong market in Orange.

Jeff Buchbinder:

In fact, in the last five years, India's almost doubled while China has actually, or this Hong Kong index anyway, has actually declined. So better environment for capital and investment, we think in India. And we continue to like India, long-term, and, you know, China's fine as a trading market, but just we're being very, very careful and still recommend an underweight to emerging markets. So that's Weekly Market Commentary. You can find it on LPL.com under the Research tab. And let's wrap up by previewing the week. And Lawrence, it's a lot of inflation and Fed, obviously. Anything else you're watching? Or do you want to just hand the ball right back to me and I got a couple other things?

Lawrence Gillum:

Well, yeah. I mean, it is Fed. It is inflation. If this were an ordinary week, CPI, PPI would be the headlines, but it's not an ordinary week. You got your Fed meeting in there. One thing that's not on this calendar that we will be paying attention to is the Bank of Japan also meets this week. Now, there's an expectation that they'll hold still in terms of rate hikes. They're kind of doing the opposite or trying to do the opposite of what everyone else is doing. They're trying to hike rates after a very long period of negative interest rates. They're positive now, but they're trying to get out of that zero interest rate policy like other central banks have done. The expectation is they're not going to raise rates this meeting, but the Bank of Japan has a history of surprising markets. So you never know, but, so that could be the wild card that we're going to pay attention to this week.

Jeff Buchbinder:

Yeah. Good point. And I mentioned the Treasury auctions. We also have some corporate news. Well, so Nvidia stock split today is certainly getting some attention. It's not down 90%. It's just split. So for anybody who wasn't aware of that. We did a little bit of research on historical performance of stock splits and it does... you do historically get a little bit of a bump initially, but by the time the split goes into effect, that bump is pretty much gone. So every stock's different. Every split's different. But if you're just looking for kind of an academic study of splits, you get a little bit of a 3 or 4% of excess return initially. It's tied to both earnings and a split because splits are often announced when earnings are announced, and then it evaporates very quickly.

Jeff Buchbinder:

Goldman Sachs did a study on this. Really, really interesting data. So, you know, we all talk about how splits don't really matter. You're just, you know, taking the stock price down and taking the shares up, and you end up with the same percentage ownership of the company. But it does have some impact in terms of liquidity. Retail folks sometimes can buy it when they wouldn't otherwise. Options trading can pick up. But even that, even in looking at liquidity, the impact isn't that great. So don't get too excited about buying a stock just because it splits. Wanted to get that in there. So what else this week? We've got the Apple Developers Conference where they're expected, widely expected, to come up with their or announced their AI strategy and AI partnership and all of that. Expectations are very, very high.

Jeff Buchbinder:

It's moved that stock quite a bit lately. So there's pressure on them to have a good story for their developers and for Wall Street for that matter. And it's a big tech week for earnings as well, because you have Adobe, Broadcom and Oracle all reporting results. So we're getting pretty close to June quarter-end when you'll get the June companies reporting. These are May companies. May order-end companies, but they are pretty big and meaningful. And there's been this narrative about AI spending is crowding out traditional enterprise spending, traditional cloud computing spending and all of that sort of thing, which probably hurt Salesforce. That stock sold off sharply, sharply on their results. So I think that narrative is going to get a lot of attention as these software and chip companies report this week. So more than just inflation. Little bit for you, Lawrence. Little bit for me. Fed and tech.

Lawrence Gillum:

We're both going to be busy this week, but our chief economist is going to be really busy this week, especially on Wednesday.

Jeff Buchbinder:

Yes. And our chief global strategist will try to figure out what's going on in France and in Germany with those election results, which certainly moved those markets a little bit today. Europe is down at last check. So, yeah. A lot going on. A lot of political crosswinds in addition to a lot of tech news, central bank news, and inflation news. So buckle up. A lot going on. So with that, we'll go ahead and wrap. Thanks Lawrence for joining. I really love it when you're on for Fed week and inflation week for that matter because markets are so focused on bonds. So glad you could join us. Thanks all of you for listening to another edition of LPL Market Signals. We'll be back with you next week. See you then. Take care, everybody.