CIO View

FOMC, reporting season and a plethora of economic indicators: Busy days ahead!

Three areas are likely to determine the fate of markets over the coming months. Firstly, the geopolitical situation. While there have been rather few headlines recently, that should not be mistaken for a de-escalation. Energy prices can serve as an important seismograph for geopolitical tensions: Hitting a peak of $86 (WTI) in early April, oil prices have since come down by $3. The price of natural gas, which had risen to €34 after a Russian attack on a Ukrainian storage facility two weeks ago, fell to €28 last week. In addition, European wholesale electricity prices have also declined since mid-April. Summing up, no news from the geopolitical side means good news for markets, confirmed by recent energy price declines.(1)

The second important topic is whether news from the current reporting season do justify elevated AI-related expectations, and demanding valuations. The third topic is the path ahead for interest rates. Regarding the former, the current answer seems to be a clear “yes and no.” Yes, as Q1 earnings numbers have been solid on average. In aggregate, Bloomberg reports an earnings beat of over 9% by now, reflecting nearly half of the S&P 500 companies that have reported their results.(2) A 9% beat would be higher compared to the past four reporting seasons, and would exceed the historical average which is more in the four percent range. So far for the good news. What’s not so good is how the market punishes stocks of companies that delivered even minor disappointments, like a somewhat less euphoric outlook compared to what markets have been hoping for. Last week, it was one big social media company’s turn, whose stocks trade 10% cheaper than where they stood a week ago. A big software giant in turn seems to have stuck the right cord, with its shares up for the week.

Which brings us to topic number three: the outlook for interest rates. The repricing of market expectations for U.S. policy rates so far this year has been nothing short of brutal. Implied Fed Funds rates for December have risen from approximately 3.8% in January to currently 5.0%, which no longer corresponds to even two rate cuts in the effective Fed Funds rate. Last Thursday, GDP Consumption Deflator data has dealt the market another blow.(3) Luckily, Fridays March personal consumption expenditure (PCE) Inflation did not come in as bad as feared in the aftermath of the GDP figures, which helped keeping 2yr Treasury yields below the 5%. We stopped counting how often they traded above that 5% mark intraday, so far however always closing below.?

With all the data for a data-dependent U.S. central bank now on the plate, this week’s big question is how the Federal Open Market Committee (FOMC) will deal with them when the committee convenes on Wednesday. Since there will be neither a rate decision, nor new forecasts, nor “dots”, etc., the full attention will be on the language of the statement and what the Fed Chair will have to say, the message perhaps explained by the Wall Street Journal shortly thereafter. We anticipate that the general intention to cut the fed funds rate this year should be reaffirmed, although the June or July meeting appear increasingly unrealistic for a first cut.

Delayed rate cuts, or the risk that there won’t be any cuts at all, would not bode well for fixed-income investors or the stock market. Moreover, it also impacts currencies, particularly in Asia. Last week, the Indonesian central bank surprised markets by not cutting rates as was widely expected, but to hike them.(4) It was maybe 30 or 40 years ago when the Bundesbank was famous for delivering surprising decisions. In today’s age of uber-transparency, with dot-plot forecasts, fan charts, detailed projections on all sorts of variables, press conferences, and the whole plethora of other transparency-enhancing measures, such a move is a bit unusual, to put it mildly. The reason behind the Indonesian central bank’s step was the exchange rate, which fell victim to U.S. rate hikes and this year’s fading expectations of U.S. rate cuts. Since early 2022, when the Western central banks went on their rate-hike journey, the price of a U.S. dollar in Indonesian Rupiah has risen from 14,200 to over 16,000, amounting to a devaluation of the Rupiah by 13%. Alone this year’s fed rate cut path repricing has cost the Rupiah 5%. Indonesia is by no means an isolated case, considering other currencies’ depreciation since early 2022. Thai Baht? Down by 11%. Korean Won? Down by 15%. Taiwan Dollar? Down by 18%.

But it’s the Japanese currency that suffered most. It now takes 158 yen instead of 115 as of early 2022 to buy one dollar, amounting to a substantial 35% devaluation. In this context, our currency strategist even started to talk about an Asian “mini currency crisis.” The Bank of Japan nevertheless chose not to mention the exchange rate in its statement after Friday’s meeting, letting the yen exchange rate hit a new low against the U.S. dollar at 158.(5) We have that gut feeling that markets have now started challenging Japanese authorities and testing out where their pain point might be before they eventually embark on currency interventions. This morning’s bounce in the Yen might be a sign that this point could have been reached at 160.

Besides Wednesday’s FOMC meeting, markets will continue to focus on incoming information from the reporting season. First April inflation rates for Europe will be published starting today, with the Eurozone number due tomorrow. On Tuesday as well, several countries will report their Q1 GDP numbers, including Eurostat with its pan-Eurozone data. In addition, the usual monthly PMIs are due, and Friday’s U.S. labor market report will round off a busy week for analysts.

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1. Source: Bloomberg, April 26, 2024.

2. Source: Bloomberg, April 29, 2024.

3. Source: U.S. Bureau of Economic Analysis, April 26, 2024.

4. Source: Bank Indonesia, April 24, 2024.

5. Source: Bank of Japan, April 26, 2024.

?Forecasts are based on assumptions, estimates, views and hypothetical models or analyses, which might prove inaccurate or incorrect. Past performance is not a reliable indicator of future returns. Source: DWS Investment GmbH as of 4/29/24.