Markets rally to new highs despite Fed hints of delayed rate cuts

SINGAPORE – A super hot jobs market and central bank signals that rate cuts are not around the corner did little to dampen enthusiasm for risk assets last week.

Boosted by better-than-expected tech earnings, Wall Street key indexes shot northwards to new records.

The Dow Jones Industrial Index rose 1.43 per cent to a record 38,654.42 points on Feb 2, taking its total gains over the past month to 3.17 per cent. The marquee 30-stock Wall Street index is now up 14 per cent from a year ago.

Meanwhile, the S&P 500 surged to a new record high at 4,958.61 points after notching up a 1.38 per cent gain last week. Boosted by stronger than expected tech earnings, this broad index of Wall Street stocks has risen 5.56 per cent over a month and is now up 20 per cent since February 2023.

The tech-heavy Nasdaq gained 1.12 per cent to 15,628.95 points, translating into a 7.61 per cent gain over a month and a whopping 30 per cent surge over 12 months.

All this was despite a searing jobs report showing that the US economy added 353,000 jobs in January, way above market projections of 185,000. This matters because more jobs means more money in people’s pockets, leading to higher potential spending and demand for goods and services, resulting in rising prices and inflation.

At least that is the theory. But the market appears to be brushing aside such theories.

Even a rather downbeat message from the Federal Reserve, where chairman Jerome Powell pronounced that the US central bank needs to see more consistent evidence of disinflation trends to justify rate cuts, did not dampen spirits.

In Singapore, the Straits Times Index put on one of its best daily gains on Feb 2 as it rose almost 37 points to 3,179.77 points, though this still translated into a somewhat meagre weekly gain of just 0.6 per cent. The benchmark Singapore index spent much of the week range trading between 3,130 and 3,160 points.

In fact, the ST Index has had a weak start to 2024, losing 2.7 per cent of its value in January after a strong rally of 5.4 per cent in December. Part of this has been due to an outflow of funds from value stocks like the banks and conglomerates to growth plays which could benefit from the tech rally and falling interest rates. According to SGX data, DBS Group Holdings, ST Engineering, Oversea-Chinese Banking Corp, Singapore Exchange, Singapore Airlines, Singtel and others have booked the most net institutional outflows last week.

So what’s next?

Although Mr Powell warned that the Fed is in no rush to cut rates, he did acknowledge disinflation and indicated that rate cuts are inevitable. But the timing would depend on the evolution of economic indicators. The Fed chief sees the US labour market as being “strong”, but also reckons it is “getting back into balance”.

The market is expecting interest rate cuts to start some time later in 2024.

But as Oxford Economics noted on Feb 2, central banks will be measured in their response to falling inflation.

“A combination of still high domestic price pressures, risks from shipping disruption, credibility concerns, and the role of the gradually loosening labour market will keep central banks cautious on policy easing,” Oxford Economics said in its weekly notes. “Lingering inflation can be attributed to excess broad money growth, tight labour markets, or both. But the fact that there’s still uncertainty over the cause suggests central banks will continue to err on the side of keeping policy tight.”

Speaking to The Straits Times last week, Mr Dan Ivascyn, managing director and chief investment officer for Pimco, sees three to four Fed rate cuts in 2024. “There is plenty of room for more aggressive rate cuts if the US economy slows down sharply,” he added.

But he also warned of the risk of elevated or re-accelerating inflation, given the prevailing geopolitical tensions. “It is premature to declare victory on inflation as events such as the war in Ukraine could still put pressure on energy and commodity markets.”

Having already misread the market in 2021 and 2022, when it declared inflation as transitory, the US central bank will want to avoid making the mistake of cutting rates too early and aggressively. It will act only if it is convinced that the decline in inflation is broad-based, sustainable, and headed towards its 2 per cent target.

So hopes for any rate cuts in March or May may be too optimistic.

Mr Vasu Menon, managing director for investment strategy at OCBC, reckons investors are slowly coming to terms with this reality, and warned that this recalibration in market expectations could cause market volatility in the short term.

“However, it is unlikely to derail markets in the medium term if the economy slows down but avoids a hard landing, inflation cools further and the Fed cuts rates steadily over the next three years,” he said. “Historically, such a backdrop has been positive for risk assets like equities and high yield bonds in the medium term. Investment grade bonds with a decent yield and a long tenor will also look more attractive when the Fed reduces rates, because rate cuts and a slowing economy usually augur well for long duration bonds and help them to post capital gains.”

That said, most analysts still see a soaring Wall Street in 2024, led by tech stocks driven by AI initiatives.

Mr Stephen Innes, managing partner at SPI Asset Management, advised investors that while remaining mindful of monetary policy decisions, they should also focus on broader economic indicators and trends to gauge the potential direction of equity markets. 

“It’s essential to recognise that economic growth has historically had a more significant impact on equity returns than movements in the yield curve,” he wrote. “During periods of robust economic expansion, stocks have tended to deliver the most substantial returns. This historical trend takes on a very bullish nuance when you factor in the strong possibility that later in the year, the Fed might consider cutting interest rates as inflation falls to prevent passive tightening through the real rates channel.”

Most analysts agree that the medium-term outlook for stocks and bonds remains positive. And investors are buying into the narrative. An American Association of Individual Investors survey indicates that the number of “bulls” (or investors willing to take risks) among US retail investors has increased markedly over the last few weeks.

Meanwhile, indicators from the European Central Bank as well as of the regional Federal Reserve banks at St Louis, Kansas and Chicago also point to lower stress levels in the financial system, and credit default premiums have narrowed.

In other words, the Goldilocks scenario which investors have been hoping for – falling inflation and interest rates, robust corporate earnings and healthy economic conditions – might play out after all. That would be good news for equity markets. If so, now may be a good time to do some savvy stock-picking.