Yields Fall on Signs of Lower Inflation, US Report Expected to Show Slowing Inflation
Last Week Review
Global equities gained another 3.4% last week, led by a 4.2% gain for developed markets outside the U.S., a 4.1% increase in emerging markets and a 3.1% return in the U.S. Treasury yields added to their year-to-date declines with the two-year Treasury yield down 0.02% to 4.23% and the 10-year Treasury yield down 0.05% to 3.50%. Trends of lower inflation helped sentiment last week.
U.S. Inflation Eases
Inflation as represented by the Consumer Price Index eased in December to 6.5% year-over-year from 7.1% in November. Core inflation, which excludes more volatile food and energy prices, fell to 5.7% from 6.0%. The month-over-month changes — arguably more timely indicators of inflation trends than year-over-year — declined 0.1% for inflation but increased 0.3% for core inflation. Services contributed to the month-over-month core inflation while goods prices continued to ease. Financial markets responded favorably to the data.
Investors Expecting Slower Fed Rate Hikes
The positive response to the U.S. inflation report likely means investors think cooling inflation will cause the Federal Reserve to slow down with a 0.25% rate hike pace at its next meeting. Commentary from several Fed officials last week suggested this outcome may come to fruition. Markets, based on fed funds futures, have nearly priced out the chance of a rate hike larger than 0.25% (versus a ~25% chance earlier in the week). Still, core services inflation remains stubborn and tight labor market dynamics (initial jobless claims declined to 205,000 last week) threaten wage growth that could keep services prices and overall inflation too high for the Fed’s comfort. The Fed is unlikely to take its foot completely off the gas soon and any downshift to less restrictive policy may be accompanied by hawkish commentary to ensure financial conditions do not loosen in “unwarranted” fashion.
China Relaxes Regulatory Pressure on Tech Stocks
China announced its regulatory crackdown on domestic tech stocks has mostly concluded. This further supported investor sentiment on China equities, which has brightened of late alongside the region’s economic reopening. Longer term concerns that led to last year’s weakness remain, but for now investors have warmed up to China equities (up around 10% year-to-date).
U.S. Bank Earnings Mostly Solid
Last week, U.S. banks reported earnings that were mostly solid versus expectations. However, light guidance (particularly related to net interest income) and warnings of economic challenges weighed on investor sentiment. Fourth quarter revenues of companies in the S&P 500 Index are expected to rise 4% year-over-year, but earnings are forecasted to decline 4%.
This Week Preview
Central Bank Response to Inflation
On inflation, investors may turn to final euro area Consumer Price Index and U.S. Producer Price Index set for release on Wednesday. On central bank activity, several Fed speakers are expected to offer comments during the week while the European Central Bank (ECB) is set to release the minutes for its most recent meeting. ECB President Christine Lagarde is also scheduled to speak at a panel. Finally, the Bank of Japan is expected to announce policy decisions on Wednesday. The post-meeting press conference may offer details on its outlook for the rest of the year.
China’s Economic Pulse Check
China’s import and export data last week painted a bleak picture with both readings down 7% to 10% year-over-year, albeit a bit better than expectations. This week’s fixed asset investment, industrial production and retail sales are likely to paint a subdued outlook as well. Investors will likely evaluate the degree to which China’s reopening allows markets to look past the near-term economic weakness.
Goldman Sachs, Procter and Gamble to Report Earnings
This week, financial services company Goldman Sachs (GS) and consumer staples company Procter and Gamble (PG) are set to report on Tuesday and Thursday, respectively. Investors are hopeful companies can exceed subdued expectations marked by margin compression and a tough demand backdrop pressuring revenue. While there is limited incentive to provide an overly optimistic outlook, there is some hope for hints of better days ahead when companies deliver guidance.
Source: Bloomberg for data, news developments and schedule of economic releases. Data as of January 15, 2023.
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