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Saturday, May 18, 2024

Markets Fell as Inflation Data Sparks Recession Fears – Weekly Market Recap

Key Takeaways:

  • While the annual inflation rates have come down significantly from their peak last summer, they remain well above the Fed’s 2% target.
  • The higher-than-expected CPI numbers prompted a sharp sell-off in stocks and a rally in the dollar as investors priced in a more hawkish Fed.
  • The path for markets will largely depend on the trajectory of inflation and interest rates.

Inflationary Fears and Market Returns

The stock market had a volatile week as investors digested the latest inflation data and comments from Federal Reserve officials. The S&P 500 index ended the week down 1.56%. Meanwhile, the U.S. dollar index (DXY) surged 1.65% to its highest level in over 5 months as expectations grew for further interest rate hikes.

S&P 500 6-Month Price Data
DXY 6-Month Price Data

The main reason for the market moves was the CPI report released on Tuesday. Headline CPI rose 0.4% last month, slightly above consensus forecasts, while the year-over-year rate ticked down to 3.5% from 3.6% in February. Core CPI, which excludes food and energy prices, also increased 0.4% and is now up 3.8% from a year ago.

While the annual inflation rates have come down significantly from their peak last summer, they remain well above the Fed’s 2% target. The stickiness of price pressures, especially in the service sector and housing, is making the central bank’s job of restoring price stability more difficult. Fed officials have emphasized that they want to see clear and convincing evidence that inflation is on a sustained downward path before considering any rate cuts.

The higher-than-expected CPI numbers prompted a sharp sell-off in stocks and a rally in the dollar as investors priced in a more hawkish Fed. The S&P 500 fell nearly 1% on Tuesday, led by declines in rate-sensitive tech and growth stocks. Short-term Treasury yields also spiked, with the 2-year yield briefly topping 4.593%, as traders bet that the Fed would have to raise rates further and keep them higher for longer.

The Federal Reserve’s Comments

In a speech last week, Fed Governor Michelle Bowman highlighted several upside risks to inflation, including geopolitical developments, fiscal stimulus, housing shortages, and the potential for inflation expectations to become unanchored. She cautioned against cutting rates “too soon or too quickly” which could cause inflation to rebound. Fed Chair Jerome Powell had a similar message in early April, noting that the central bank does not expect to lower rates until it has “greater confidence that inflation is moving sustainably down toward 2 percent.”

The minutes from the Fed’s March meeting, released on Wednesday, showed that “almost all” officials agreed it would be appropriate to move to a less restrictive policy stance at some point this year if the economy evolves as expected. However, policymakers “emphasized the importance of carefully assessing incoming data to judge whether inflation is moving down sustainably to 2 percent” before making any adjustments. The minutes also revealed that the Fed is likely to slow the pace of balance sheet reduction “fairly soon” as bank reserves approach more normal levels.

Economic Data and Earnings

Initial jobless claims fell to 211,000 last week, slightly below estimates, while continuing claims rose to 1.82 million, the highest since January. The mixed labor market data suggests that while the job market remains historically tight, it may be gradually softening at the margins. Still, with the unemployment rate at 3.8%, the Fed appears to have more room to keep tightening policy without causing a severe recession.

The first-quarter earnings season kicked off with generally solid results from the big banks. JPMorgan Chase, Citigroup, and Wells Fargo all topped revenue and profit expectations. However, the banking sector took a hit as their income on net interest fell.

JP Morgan 6-Month Price Data
Citigroup 6-Month Price Data
Wells Fargo 6-Month Price Data

In commodity markets, oil prices fell on concerns about slowing global growth and rising U.S. inventories. Crude Oil fell to $85.46 per barrel. Gold prices were volatile but ended the week little changed as the dollar’s strength offset safe-haven demand. Spot gold edged up 0.60% to $2344.14 an ounce. Silver outperformed its precious metal peer, rising 1.9% to $27.98 an ounce.

Crude Oil 6-Month Price Data
Gold 6-Month Price Data
Silver 6-Month Price Data

The Possible Path for Markets

Looking ahead, the path for markets will largely depend on the trajectory of inflation and interest rates. If price pressures continue to moderate and the economy cools gradually, the Fed may be able to engineer a soft landing and avoid a recession. However, if inflation proves more intractable or the labor market remains too tight, policymakers may have to raise rates more aggressively, increasing the risks of a hard landing.

For now, investors appear to be betting that the Fed will hike rates to around 5.5% by mid-year and then keep them there for an extended period.

The other main risk for markets is the health of the banking sector, particularly regional banks with large exposures to commercial real estate. While the recent turmoil has calmed somewhat, thanks in part to the Fed’s emergency lending programs, concerns linger about the impact of higher rates and tighter credit conditions on banks’ balance sheets and loan portfolios. Any renewed stress could cause financial conditions to tighten further and weigh on economic growth.

The central bank appears determined to keep policy restrictive until it is confident that inflation is firmly on track to return to 2%. While a severe downturn is not inevitable, the path to a soft landing looks increasingly narrow.

Want more context? Read our last market recap from the week before

Lazarus
Lazarushttps://ljlnews.com
Publisher and editor of LJLNews. I am a Stock Market enthusiast, with an interest for politics. I hope you enjoy reading the articles! Contact me at: Lazaruslucas@ljlnews.com

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