Due to last Wednesday’s “hot” Consumer Price Index (CPI) release and a 10-year Treasury bond auction the same day, 10-year Treasury bond yields surged 20 basis points, from 4.36% to 4.56%. Due to this surge, it will be difficult for Fed Chairman Jerome Powell to achieve a consensus for a June rate cut. Thursday’s Producer Price Index (PPI) release was more moderate, so there is still some slim hope for a Fed rate cut in June. The European Central Bank (ECB) has already telegraphed a June rate cut, so if the Fed fails to follow suit, we can expect the U.S. dollar to continue rising. Actually, ECB President Christine Lagarde said that a “few” on the ECB Governing Council were ready to cut key interest rates last week, on Thursday, so a euro rate cut, likely by June, could come sooner. Previously, it was perceived that both the ECB and the Fed would coordinate their interest rate cuts in June. However, some Fed watchers now expect the Fed to wait until later, or make no cuts at all in 2024.
Here is the most important market news items and what this news means:
* The Commerce Department announced this week that retail sales rose 0.7% in March, which was substantially higher than economists’ consensus expectations of a 0.3% increase. Also encouraging is that sales at bars and restaurants rose 0.4% in March, which is a sign that consumers are getting out and about as well as spending disposable income. Due to the strong March retail sales report and February upward revision, economists will now be revising their first-quarter GDP estimates higher.
* The 10-year Treasury bond is now at 4.64%, up from just 4.19% less than a month ago. The perception is that the Fed will postpone any key interest rate cuts until July or later, but with a Presidential election forthcoming, the Fed may want to hurry up and cut key interest rates to try to stay out of the political spotlight.
* If the ECB cuts and the Fed doesn’t, it’s going to result in a very, very strong dollar. A strong U.S. dollar naturally raises crude oil prices for the rest of the world, since crude oil is priced in U.S. dollars. There were fears of $100 crude oil after Mexico slashed its crude oil exports. Oil shipments from Mexico dropped 35% in March and are now at their lowest level since 2019 after Pemex canceled some supply contracts with foreign refiners, including U.S. refiners. Iraq, Qatar, and UAE also curtailed their crude oil exports in March. Overall, one million barrels per day of crude oil exports disappeared in March, just as seasonal demand is ramping up.
* The attack that everyone expected – Iran retaliating against Israel – happened late Saturday, but apparently not one of Iran’s 300 or more missiles and drones reached its target in Israel. Israeli Prime Minister Benjamin Netanyahu, speaking from an air base in southern Israel, said, “Whoever harms us, we will harm them. We are prepared to meet all of the security needs of the State of Israel, both defensively and offensively.” The U.S. Navy has also relocated its warships to protect Israel, so tension remains high. Obviously, if the fighting in the Middle East escalates further, crude oil prices will keep rising.
* Turning to other ongoing war news, a Russian naval missile carrier was struck by two drones in the Baltic Sea. Ukrainian military intelligence is reported behind the attack. The conflict between Ukraine and Russia is now occurring farther away from the actual border fighting. A recent Ukrainian drone attack on a refinery deep in Russia is another example of how the current conflict is expanding. Due to this war and the Middle East war’s escalation, crude oil prices are expected to remain high, since Russia’s energy exports have been curtailed after four of its refineries have been attacked by Ukraine in recent months.
* Republican Senator Tom Cotton accused the Biden administration of discouraging Ukrainian actions for political reasons, saying, “It sounds to me like the Biden administration doesn’t want gas prices to go up in an election year.” Rising gasoline prices at the pump hurt President Biden’s reelection chances, so he has decided to buy some more votes by offering student loan relief for up to 26 million voting-age Americans.
The earnings season is just getting started and while it’s generally been beats so far, the market focus has been distracted by the geopolitical developments and the backup in interest rates. But with rates reacting to strong consumer spending and general economic strength, the earnings season is likely to be strong. Once stock indexes and interest rates stabilize, and geopolitical risks subside, solid earnings should bring money in from the sidelines. A 200 point / 4% drop in the S&P should be seen as an attractive buying opportunity.
