While the U.S. stock market has priced in a “soft landing” scenario for the economy, an underwhelming January jobs report, relatively strong corporate earnings and Federal Reserve Jerome Powell's comments last week could point to the possibility of a “no landing.” Where the economy is resilient while inflation remains the target.”
According to Richard Flax, chief investment officer at Moneyfarm, such a scenario could still be positive for US stocks as long as inflation remains stable. However, if inflation accelerates again, the Fed may be reluctant to cut its key interest rate sharply, which could cause problems, Flax said in a call.
What the past week has told us
Investors just endured their busiest week so far this year for economic data and corporate earnings reports, with stocks ending at or near their record highs.
According to Dow Jones Market Data, the Dow Jones Industrial Average DJIA ended the week with its ninth record close of 2024. The S&P 500 index SPX posted its seventh record close this year on Friday, while the Nasdaq Composite COMP was about 2.7% below its peak is.
As expected, the Fed left its key interest rate unchanged in the range of 5.25% to 5.5% at its Wednesday meeting. However, in the subsequent press conference, Fed Chairman Jerome Powell contradicted market expectations that the central bank could start cutting its key interest rate in March, emphasizing that they want “greater confidence” in fighting inflation.
Roger Ferguson, a former Fed vice chairman, said Powell “introduced a new kind of risk, the risk of a non-landing event.”
In that scenario, inflation will stop falling while the economy is strong, Ferguson said in an interview with CNBC on Thursday. However, Ferguson said he did not think that was the likely outcome.
Traders on Friday were pricing in a 20.5% chance that the Fed will cut interest rates at its March meeting, according to the CME FedWatch tool. A week ago the probability was over 46%. The probability that the Fed will start its interest rate cutting program in May was 58.6% as of Friday.
Stronger-than-expected January labor market data released Friday further rules out the possibility of a rate cut in March, Flax said.
The U.S. economy added a whopping 353,000 jobs in January, while economists polled by the Wall Street Journal had forecast a 185,000 increase in new jobs. Hourly wages rose sharply by 0.6% in January, the strongest increase in almost two years.
The past week was also full of earnings reports as several tech giants, including Microsoft MSFT, +1.84%,
Apple A`L, -0.54%,
At META +20.32%,
and Amazon AMZN, +7.87% reported their fourth-quarter 2023 financial results.
Of the 220 S&P 500 companies that have reported earnings so far, 68% have beaten estimates, with their earnings beating expectations by an average of 7%, Fundstrat analysts wrote in a note Friday.
While major technology companies' reported earnings are “fine,” the forecast is not, said José Torres, senior economist at Interactive Brokers.
What has driven the rally in technology stocks since last year has largely been the prospect of sales from artificial intelligence products, but technology companies are not yet in a position to monetize that trend, Torres said in a telephone interview.
Adding to the headwinds is the comeback of concerns about regional banks.
On Thursday, New York Community Bancorp Inc. shares triggered the sharpest decline in regional bank stocks since the Silicon Valley bank collapsed in March 2023. New York Community Bancorp posted a surprise loss on Wednesday, signaling challenges in the commercial real estate sector with distressed loans.
Meanwhile, the Fed's bank term refinancing program, launched in March last year to strengthen the banking system's capacity, will expire on March 11.
If the Fed could start cutting its key interest rate in March, it would be “kind of like an ambulance that would pick up and save regional banks,” Torres said. “Now the ambulance won’t arrive until May at the earliest. I think we are in a particularly risky period between now and May,” Torres said.
What should investors do?
According to Torres, investors should avoid risk before May. “Last year, goods and commodities helped a lot on the disinflationary front. For the fight against inflation to continue this year, we will need services to help achieve this. Then we have to see an increase in the unemployment rate,” Torres said.
He said he prefers U.S. Treasury bonds with maturities of four years or shorter because the long-term bonds may be vulnerable to risks related to the budget deficit and national debt. When it comes to stocks, he prefers the healthcare, utilities, consumer staples and energy sectors, he said.
Keith Buchanan, senior portfolio manager at Globalt Investments, is more optimistic. The slowing inflation and relatively good economic data and earnings “don't really paint a picture of a risk-off scenario,” he said. “The setup for risk assets still leans towards a bullish expectation,” Buchanan added.
Next week, investors will be watching ISM services data on Monday, US trade deficit on Wednesday and weekly initial jobless claims numbers on Thursday. Several Fed officials will also speak and may provide further guidance on the possible path of rate cuts.
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