CIO View

Markets, priced for perfection, are waiting for the Fed

Was this now a strong or a weak U.S. labor market report? As usual, the release contained something for both the optimists and the pessimists. The optimists took pleasure in 275k new jobs, 75k more than expected. The pessimists, on the other hand, point at a downward revision of the previous months' employment figures by 167k, as well as an unemployment rate rising from 3.7% to 3.9%. We have some sympathy for a cautious interpretation.

A weakening U.S. economy and, as a derivative, a weakening labor market in itself should not be big news. Actually, this is what the 525 basis points of U.S. policy rate hikes should deliver. In other G7 countries and beyond, the tightening of monetary policy is having exactly the desired effect. The economic laws of nature should apply to everyone, including the United States. ISM Purchasing Managers' Indices (PMIs) point to falling U.S. employment, for some time now in the manufacturing sector and more recently also in services. Not that the stock market cares, or does it?

It's now the consensus that the U.S. economy is not going into recession, and the only question that remains is whether it's a soft-landing scenario or no landing at all. We would argue that this is now not only the consensus, but it has become a necessary condition. As the headline on the Barron's website reads: "This Bull Still Has Plenty of Fight" (1) and "Stronger economic growth can keep fueling the stock market's rally." (2) So far this year, the market moved up at a straight line, bringing back all those "strongest market without a correction since …" statistics. Not closing at a new all-time high on Friday was nothing more than a minor inconvenience. But then, suddenly last weeks’ big semiconductor stock turned around (3), closing 10% below its daily (and historical) high, which represented an intra-day swing in market-cap of more than USD 200 billion. While we will leave the analysis of individual stocks to our gifted equity colleagues, we’d consider Friday’s move another reminder that this market appears to be priced for perfection, without much margin for error.

In Ukraine, things look like anything but perfection. This brings back new, or rather old, ideas on how Europe could finance its support for Ukraine: Eurobonds. For many finance ministers, getting them on board probably won't take much persuasion, except maybe in the case of Berlin and a few of its allies. Bloomberg quotes investors who are open-minded as well (4): "Investors are thirsty for these bonds," one portfolio manager told them. The strong demand for EU bonds is confirmed by numbers, as "a €3 billion […] EU bond received €81 billion in orders." If, after 25 years of a common monetary policy, Vladimir Putin were to succeed in getting Europe to finally agree on deeper fiscal integration, he might even be a hot candidate for the "Charlemagne Prize", which honors personalities for outstanding contributions to European unification.

The last time Eurobonds were discussed, the intention was to save the European Monetary Union as a whole. From today's perspective, it was probably the right decision not to introduce them back at the time in order to force countries living beyond their means to embark on reforms. The strategy worked, as the current account surpluses of Spain, Portugal, Ireland and Italy confirm. Only Greece has fallen back into old bad habits, with its current account deficit of over 7% of GDP. Athens should remind us that, even if further integration steps are now hastily decided in light of Putin's threat, the focus on economic stability should not be lost sight of.

But before a decision on Eurobonds is due, markets will first have to deal with the U.S. Federal Reserve (the Fed), which will meet on March 20. It is almost certain that there won’t be a rate cut next week, and May no longer appears a realistic option either. Hence the main focus will be on the dots, the new forecasts and Powell’s rhetoric in order to determine whether June will remain in the race, as markets are currently pricing, or whether it could take even longer until the first cut. February U.S. consumer price index (CPI) data, to be published tomorrow, will be important in this context, as will be Thursday’s U.S. retail sales and the University of Michigan consumer confidence index on Friday.

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1. Source: Barrons, March 10, 2024.

2. Source: Barrons, March 8, 2024.

3. Source: Bloomberg, March 9, 2024.

4. Source: Bloomberg, March 10, 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 3/11/24.

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