Investors Brace for 5% Treasury Yields as US Inflation Worries Mount

Economic

Summary:

As U.S. inflation worries grow, some investors are preparing for the 10-year U.S. Treasury yield to breach a 16-year high of 5% hit last October.

Bond yields, which move inversely to prices, have climbed in recent weeks as signs of persistent inflation erode expectations for how deeply the Federal Reserve will be able to cut interest rates without further fueling consumer prices. The yield on the benchmark 10-year note is up 80 basis points this year and last stood at 4.70%, a five-month high.

Many investors are betting further weakness lies ahead for bonds. Global fund managers' fixed income allocations in the latest BofA Global Research survey are down to their lowest level since 2003. Bearish Treasury positioning among some classes of hedge funds stands at its highest level of the year, according to BofA data, even as other asset managers have increased their bullish bets.

"It all boils down to one word: inflation. If the market doesn't see signs that inflation is contained, then there's no reason that yields won't keep pushing higher," said Don Ellenberger, senior portfolio manager at Federated Hermes. He has decreased his portfolio's interest rate sensitivity, wary that sticky inflation and labor market strength could push yields as high as 5.25%.

Further evidence that inflation is heating up again came on Thursday, with data showing the personal consumption expenditures (PCE) price index excluding food and energy rose far more than expected in the first quarter. Futures markets showed investors now expect the Fed to deliver just 35 basis points in rate cuts this year, compared to the more than 150 points that were priced in at the beginning of 2024.

Another hot inflation reading on Friday, when PCE data for March will be released, could further close the window on rate-cut expectations this year. More insights on the economy could come at the conclusion of the U.S. central bank's monetary policy meeting on May 1.

'High-water mark'

The level of Treasury yields is closely watched by market participants, as elevated yields can translate into higher borrowing costs for consumers and companies and tighten financial conditions in the economy.

A sharp run-up in yields during the latter part of 2023 sparked a sell-off in the S&P 500, though equities rebounded when yields reversed. This year's rally in stocks has stumbled in recent weeks as yields have risen, with the S&P 500 cutting its gains to around 6% on a year-to-date basis, from more than 10%.

Some investors have used the weakness in bonds to add to their fixed income holdings, confident that yields are unlikely to rise much further unless the Fed says it is looking to once again raise its benchmark overnight interest rate from the current 5.25%-5.50% range. Others, however, have been skeptical inflation will cool anytime soon.

"Inflation is not coming down like the Fed thought it was," said Arthur Laffer, president of Laffer Tengler Investments, who is bearish on longer-dated Treasuries and believes yields could rise as high as 6%. "You're not getting paid to take risk in the bond market right now."

Michael Purves, head of Tallbacken Capital Advisors, wrote it's "not inconceivable" that the 10-year Treasury yield could reach its 2007 high of 5.22%, if higher prices for oil and other raw materials continue pushing up inflation.

The price of Brent crude is up about 17% on a year-to-date basis, even after retreating in the last week on easing fears of a wider conflict in the Middle East.

Fiscal worries are another factor that could push yields higher. Ratings agency Fitch downgraded the U.S. credit rating last year partly due to concern over rising debt levels. Many investors anticipate a rise in term premiums - or the compensation demanded to hold long-term debt.

"The fiscal conditions of the U.S. are starting to matter, and it can put tremendous pressure on yields and push down on equity valuations in a very short period of time if the market starts to worry more," said Bryant VanCronkhite, a senior portfolio manager at Allspring Global Investments, who expects 10-year Treasury yields to move above 5%.

Still, there are reasons to think a return to 5% yields would be a "high-water mark" for investors, said Alex Christensen, a portfolio manager at Columbia Threadneedle Investments who is overweight two-year Treasuries.

The market narrative that dominated since the so-called Fed pivot in December "was very one-sided and left little room for changes in the inflationary trend," Christensen said.

He believes the Fed is unlikely to pivot towards rate increases.

"We think the general inflationary trend is stable to lower," he said.

Source: Reuters

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ING

Economic

Even German consumers are brightening up. Consumer confidence increased to the highest level in two years at -24.2 in May, from -27.3 in April. Looking at the details of consumer confidence in April, German consumers had become more optimistic regarding their own income expectations. Willingness to both spend and to save increased somewhat, indicating that despite more optimism, the German consumer remains cautious.

Private consumption to pick up over the next months.

The German economy has entred a phase of cyclical improvements, as indicated by Ifo index, but also by hard macro data for the first two months of the year. Somewhat surprisingly, the current improvement has been driven by a rebound in industrial activity, trade and weather-driven stronger activity in the construction sector. Private consumption, however, has stayed behind. Retail sales had dropped for four months in a row since November last year and consumer confidence has been more than muted. Today’s improvement in consumer confidence suggests that private consumption could also gradually improve over the coming months.

Looking ahead, with nominal wage increases of some 7% year-on-year in the first quarter, 2024 should be the year with the strongest increase in real wages in almost a decade. Some pick-up in private consumption after the consumption slump of the winter months will happen. However, with prices remaining high, as well as geopolitical but also domestic policy uncertainty and the gradual turning of the labour market, chances are high that German consumers will rather opt for precautionary savings.

Still, let’s focus on the positives. After a long period of disappointing macro news out of Germany, optimism has finally returned. The cyclical trough is behind us, but this doesn’t necessarily mean that a strong recovery is imminent as structural weaknesses remain. In fact, an unpleasant risk of this cyclical improvement could be that it gives rise to policy complacency, which in turn would further delay the necessary structural improvements.

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FastBull Featured

Remarks of Officials

On April 25, local time, Wall Street Journal correspondent Nick Timiraos wrote as follows.

Investors and Fed members had hoped that a further decline in inflation would facilitate the decision to cut interest rates in the summer, but Thursday's economic activity report disappointed them. Conversely, data from the Commerce Department showed that inflation remained sticky for the third consecutive month after a sustained cooling last year.

Individual data on the economy and inflation have not been enough to change the Fed's outlook this year. However, the cumulative effect of a series of disappointing data is significant. In particular, inflation data, which has been stronger than expected, has led investors and the Fed to reconsider whether rate cuts are needed this year.

In addition, economic growth has been more resilient than expected. According to the US Department of Commerce, GDP grew at a 1.6% annual rate, while underlying demand suggested a stronger 3% rate, indicating strong economic growth momentum. Also, the report said that the inflation data for January and February may be revised upward. In other words, real inflation will be higher than the original report. This indicates that inflation is not easing and upcoming price data for March is expected to show continued strong inflation.

Fed officials have been signaling a rate cut since late last year and expect inflation to fall to 2.5% later this year, followed by 2%. Core PCE inflation has grown in line with Fed forecasts over the past two quarters, and the data has led to optimism that the Fed may have managed to bring inflation under control without the need for more aggressive measures.

Fed Chair Jerome Powell was not overly concerned about the high inflation data at the beginning of the year, believing that it was just a "bump" in the road to inflation. Even at last month's press conference, he said that the data did not change the overall picture of the evolution of inflation. But last week, Powell acknowledged that his way of thinking about inflation has its limits, saying that stronger inflation in March could delay a rate cut for several months.

Timiraos' Article

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Alex

Economic

US economic growth slid to an almost two-year low last quarter while inflation jumped to uncomfortable levels, interrupting a run of strong demand and muted price pressures that had fueled optimism for a soft landing.

Gross domestic product increased at a 1.6% annualized rate, below all economists’ forecasts, the government’s initial estimate showed. The economy’s main growth engine — personal spending — rose at a slower-than-forecast 2.5% pace. A wider trade deficit subtracted the most from growth since 2022.

A closely watched measure of underlying inflation advanced at a greater-than-expected 3.7% clip, the first quarterly acceleration in a year, the Bureau of Economic Analysis report showed Thursday. US Economy Slows And Inflation Jumps,Damping Soft-Landing Hopes_1

US Economy Slows And Inflation Jumps,Damping Soft-Landing Hopes_1

The figures represent a notable loss of momentum at the start of 2024 after the economy wrapped up a surprisingly strong year. With the inflation pickup, Federal Reserve policymakers — who were already expected to hold interest rates at a two-decade high when they meet next week — may face renewed pressure to further delay any cuts and even to consider whether borrowing costs are high enough.

Treasuries slid and the S&P 500 opened lower, with traders pushing out the expected timing of the Fed’s first interest-rate cut to later this year.

“The hot inflation print is the real story in this report,” Olu Sonola, head of US economic research at Fitch Ratings, said in a note. “If growth continues to slowly decelerate, but inflation strongly takes off again in the wrong direction, the expectation of a Fed interest rate cut in 2024 is starting to look increasingly more out of reach.”

The first-quarter pickup in inflation was driven by a 5.1% jump in service-sector inflation that excludes housing and energy, nearly double the prior quarter’s pace. March figures on inflation, consumer spending and income are due Friday.

Federal government spending subtracted from GDP for the first time in two years. Business inventories dragged for a second straight quarter.

Stripping out inventories, government spending and trade, inflation-adjusted final sales to private domestic purchasers — a key gauge of underlying demand — rose at a 3.1% rate.

The GDP report showed outlays for services rose by the most since the third quarter of 2021, fueled by health care and financial services. Spending on goods decreased for the first time in more than a year, restrained by motor vehicles and gasoline.

Residential investment jumped at a nearly 14% annual rate, the fastest since the end of 2020 and underscoring builder efforts to boost inventory.

At next week’s Fed meeting, traders will parse Chair Jerome Powell’s comments for clues about the latest thinking around easing policy. He’s previously said that growth can run at a faster rate without stoking inflation thanks to supply-side improvements like immigration, which is boosting the size of the workforce.

Separate data out Thursday showed initial applications for unemployment benefits fell to 207,000 last week, the lowest level in two months. Continuing claims also decreased.

The GDP and inflation figures represent more hurdles for President Joe Biden, who has been trying to convince Americans he’s been doing a good job on the economy. Consumer sentiment has moved sideways in recent months, and voters in key swing states are pessimistic about the outlook.

Source:Bloomberg

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Alex

Economic

Stocks

Shares of Meta Platforms sank 13% on Thursday, sparking a selloff in big technology stocks after the social media firm signalled its costly bet on artificial intelligence (AI) could take years to pay off.

The drop was set to erase nearly US$170 billion (RM811.96 billion) from the company's market value and triggered a fall of 3% to 4.2% in shares of AI-focused Microsoft and Alphabet, both of which report earnings after market close.

The focus on AI spending, however, sparked a more than 2% jump in shares of Nvidia, Broadcom and Marvel Technology, which analysts have called the picks and shovels of the generative AI boom. Intel, which has missed out on the AI-led rally, was up 0.7% ahead of earnings.

Meta CEO Mark Zuckerberg, who floored Wall Street last year with his cost-cutting drive, said on a post-earnings call that costs would grow "meaningfully" over the coming years before the company makes "much revenue" from some of its AI products.

That stoked investor fears that Zuckerberg was plunging Meta into another costly endeavor at a time when its augmented and virtual reality business was losing billions of dollars each quarter.

"Investors were caught off guard by higher capital expenditure, exacerbated by slightly softer second-quarter revenue guide. As such, shares are entering the 'penalty box,'" Baird Equity Research analysts said.

Meta forecast April-June revenue below estimates and raised the bottom end of its 2024 total expense forecast by US$2 billion on Wednesday. It also raised the top end of its capital expenditure view as it invests in data centers essential to its efforts to catch up with AI frontrunners OpenAI and Microsoft. Meta Sparks Tech Selloff as AI Splurge Spooks Wall Street_1

Meta Sparks Tech Selloff as AI Splurge Spooks Wall Street_1

The dour expectations follow a series of smash-hit earnings that helped Meta nearly triple its stock in 2023 and powered the biggest one-day market value gain by any company in Wall Street history, of US$196 billion, in February after its maiden dividend.

Still, several analysts were positive on the investments, pointing to AI-driven engagement on content such as Instagram Reels and the warm reception for its virtual assistant Meta AI and early versions of its latest large language model, Llama 3.

"We think this time it is different," Evercore ISI analysts said. "This investment cycle comes from a position of strength, as management continues to see a healthy ad demand environment into 2Q and improving user engagement."

Overall, 19 analysts lowered their price targets on the stock, while 13 raised their view, according to LSEG data. The median price target now stands at US$525, which is about 6% higher than its previous close.

The stock has a 12-month forward price-to-earnings ratio of about 23.12, compared with Microsoft's 31.17 and Alphabet's 22.07. It has gained nearly 40% so far this year, comfortably above the benchmark S&P 500 index's 6% gain.

"Being on the offensive with investment spending is generally great, but in internet it is very hard to underwrite which of those investments will pay back and when," Bernstein analyst Mark Shmulik said.

"All of this culminates with investors wondering just how long this investment cycle will last, whether the opportunity and payback is real, all against a backdrop of decelerating growth."

Source: Reuters

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Data Interpretation

During the Asian trading session on April 26th, the Japanese Statistics Bureau released the latest Tokyo CPI.

Headline Tokyo CPI for April rose 1.8% YoY, while the previous reading was 2.6%, and the expected reading was 2.5%;

Tokyo core CPI for April was 1.6%, vs. 2.4% previously and 2.2% expected;

Tokyo core-core CPI for April was at 1.6%, vs. 2.9% in the previous month;

All data were significantly lower than both the previous reading and the forecast, and also far below 2%. The "distortion" is largely attributed to the start of education subsidies, which will not affect Japan's national CPI data for April, scheduled for release on May 24th.

The impact of education subsidies is a one-time factor. However, there are other signs that the weakness will last longer. Food inflation is easing and energy prices have not risen significantly, suggesting that the weak yen has not pushed import prices much higher. As inflation eases down and real wage growth turns positive, these could support consumption. But this is different from the potential rise in inflation that the BOJ is hoping for. In addition, these data may keep the BOJ cautious regarding policy decisions.

The data was surprising. But before the data was released, analysts had already issued warnings in advance. Morgan Stanley economist Takeshi Yamaguchi warned on Thursday that Tokyo CPI in April might plunge sharply due to the implementation of measures such as free high school education.

The BOJ's April interest rate decision is about to be announced, and the significant decline in Tokyo's single-area CPI data due to the one-off factor is unlikely to change the BOJ's policy stance. However, it could deepen traders' view that monetary easing will continue, which in turn could increase the yen's depreciation pressure.

Tokyo CPI for April

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Cohen

Economic

UK consumer confidence edged higher this month as easing inflation and the prospect of further tax cuts made people more willing to spend, a survey found.

GfK Ltd. said its key gauge of household sentiment rose to minus 19, up 2 percentage points from March and well above the minus 30 recorded in April last year when the cost-of-living crisis was still exerting a painful grip. UK Consumer Confidence Improves As Inflation And Taxes Fall_1

UK Consumer Confidence Improves As Inflation And Taxes Fall_1

The improvement came in a month that saw inflation fall to its lowest since 2021, national insurance payroll taxes cut and domestic energy prices drop to their lowest in two years. There were also signs the economy is recovering from last year’s shallow recession.

That’s good news for Prime Minister Rishi Sunak, who is counting on rising living standards to deliver a “feel-good factor” ahead of an election widely expected in the autumn. With his Conservative Party trailing in opinion polls, Sunak has made no secret of his desire to cut taxes again before the vote.

“Spring has arrived and maybe consumer confidence is, at last, slowly becoming brighter and heading in the right direction,” said Joe Staton, client director at GfK.

Four of the five measures that make up the index rose this month, with consumers declaring themselves less pessimistic about the economic outlook and more willing to splash out on big-ticket items.

An index tracking how Britons feel about their financial prospects remained at plus 2, showing more expect things to get better than worse in the coming year.

GfK cautioned, however, that overall confidence has a long way to go to return to the positive readings last recorded before the Brexit referendum in 2016.

Hopes are fading that the Bank of England might cut interest rates as early as the summer after warnings by policymakers about the threat from persistent inflation. Markets are now pricing in just two reductions this year, having signaled as many as six back in January.

“While it’s welcome to see confidence levels rising, households are still feeling squeezed, so it’s not yet equating to a consistent and significant upturn in consumer spending,” said Linda Ellett, UK head of consumer, retail and leisure at KPMG.