Bond Yields Jump as Hot Inflation Curbs Fed Wagers

Markets bet that the U.S. Federal Reserve will be in no rush to cut rates, with U.S. 10-year yields climbing 10 bps.

Wall Street grapples with another hot inflation print.

The world’s biggest bond market sold off after another hot inflation report reinforced bets that the U.S. Federal Reserve will be in no rush to cut rates even as some areas of the economy show signs of sluggishness.

Treasury yields climbed and stocks retreated as the data underscored the Fed’s challenges in achieving its 2 percent inflation goal. Following the steps of the consumer-price data, the producer price index (PPI) also signaled a pickup in cost pressures. In contrast, retail sales missed estimates. While it’s probably too early to draw any conclusions, the set of figures raised some eyebrows about the specter of stagflation.

“Well, this is a pickle,” said Chris Low at FHN Financial. “On the heels of a second steamy CPI, and just a week before the Fed meeting, the February PPI rises at twice the expected pace. Retail sales were ‘meh’ at best, if not downright weak.”

U.S. 10-year yields climbed 10 basis points (bps), to 4.29 percent. Traders pared bets on Fed cuts in 2024, with swaps fully pricing in a first move in July. The S&P 500 fell to around 5,150 ahead of today’s options expiration—which has the potential to amplify volatility. The dollar rose. Oil topped $81.

“In a way, today was the past month in microcosm—sticky inflation combined with signs of softness elsewhere in the economy,” said Chris Larkin at E*Trade from Morgan Stanley. “The questions now are: Will traders rethink how soon the Fed will cuts rates? And will that slow down the stock market rally in any meaningful way?”

The inflation numbers are just not giving policymakers any incentive to ease, said Andrew Brenner at NatAlliance Securities.

For the fifth straight gathering, the Federal Open Market Committee (FOMC) is expected to keep rates unchanged at next week’s meeting. Coming on the heels of reports warning of persistently high inflation, the focus will be on the Fed’s new “dot plot.” The median forecast of policymakers in December showed three quarter-point rate reductions for 2024.

Over two days on Capitol Hill earlier this month, Fed Chair Jerome Powell gave no evidence he was bothered by surging asset prices—which arguably work against his goal of keeping financial conditions tight enough to wring excesses out of the economy.

“Equity and bond bulls are staring at their calendars and drawing a big red circle around the 20th of this month,” said Jose Torres at Interactive Brokers. “Folks are concerned Powell may have to pull a dangerous U-turn during his ride on the monetary-policy highway. His dovish messaging since December has driven an intense loosening in financial conditions.”

Ellen Zentner at Morgan Stanley says she expects little change to the Fed statement and the projections—with the median dot remaining at three cuts.

“Key risk: It would take just two participants to change from three cuts to two for the median dot to move to a total of two cuts in 2024—underscoring that the risk tilts toward fewer rather than greater,” she noted. “Chair Powell is unlikely in the ‘two camp,’ and we think will push to keep the median at three.”

With February’s CPI and PPI data in hand, Bloomberg Economics estimates that the core PCE deflator—the Fed’s preferred inflation indicator—and core services excluding housing, known as “supercore,” will both moderate.

While the February PPI was stronger than expected, the details that affect PCE inflation were on the “softer side,” according to Bank of America Corp. economists including Michael Gapen.

“We continue to expect the Fed will start its cutting cycle in June,” they said. “However, it will need to see more improvement in the upcoming inflation data to have enough confidence to begin to ease.”

Amid all the economic and policy uncertainties, equities also struggled on Thursday. That happened at a time when high valuations of a few mega-caps have pushed some market observers to worry about a bubble.

Markets are showing characteristics of a bubble in the record-setting surge by tech’s so-called ‘Magnificent Seven’ stocks and the all-time highs in cryptocurrencies, according to Bank of America Corp.’s Michael Hartnett. With inflation re-accelerating, growth a little soft, and risk assets unscathed, “that is very symptomatic of a bubble mentality,” Hartnett told Bloomberg Television.

While the top 10 stocks in the benchmark index are indeed historically expensive relative to the rest of the market, the other 490 are also trading at multiples significantly above their long-term averages, according to Ned Davis Research’s Ed Clissold.

If a bubble is forming in U.S. stocks, it has plenty of room to expand before it bursts, according to strategists at Societe Generale SA.

A team at the bank led by Manish Kabra said the S&P 500 can climb to 6,250—over 20 percent above its current level—before reaching the multiples seen at the peak of the dot-com boom in 2000. That suggests the stock market can continue its sharp advance despite brewing worries that it has run up too far.

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This story was produced with the assistance of Bloomberg Automation.

 

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