An inauspicious start to 2024

After the euphoria of 2023, the reality of 2024 has brought the bullish sentiment that drove big gains for risky assets at the end of last year to a halt. The larger than expected payrolls number for December in the US, slightly more nuanced FOMC minutes and stronger than expected readings for Eurozone inflation have hit stocks markets and triggered a big recovery rally in the USD. In recent weeks some analysts had predicted that the USD would have a difficult year, that may turn out to be the case, but USD/JPY has risen by a respectable 3.23% so far this week, with a 0.5% jump after the better-than-expected US payrolls data.

Looking at the US payrolls report for December closely, the market had expected a reading of 170k, however, the actual figure for December was 216k. This is significant since 200k is considered a line in the sand for payrolls. It is amount by which the US economy needs to create jobs to ensure that the labour market is expanding. The reason why we have seen risk sell off on the back of this figure is because the Federal Reserve is at an important point in its policy cycle. It has tightened policy so far that it is now at a pause, but it is still using the economic data and the state of the labour market as a way to determine when to cut interest rates. If the labour market in the US is still expanding, then it makes rate cuts less likely.

Reduced expectations of a March cut from the Fed

The market has adjusted its expectations of when the Fed will start hiking rates, the CME Fedwatch tool is now expecting a 53% chance of a 25bp rate cut in March, which is below the 62% chance expected on Thursday, and well below the 73% chance of a rate cut priced in by the market one year ago. At the end of 2023 it seemed like the market was fixed in its view that the Fed would cut rates and everything would rally, 2024 has been a lesson in reality: when US economic data is strong, expectations of rate cuts are eroded and this hurts risky assets and boosts the dollar. Thus, as we move through the first week of January, it looks like the “everything rally” is firmly behind us.

Digging into the labour market report

Other details of the labour market report are worth noting, average wage data rose to 4.1% YoY, higher than the 3.9% expected. A 4% handle on wage growth in the US could also make the Fed think twice about cutting rates too quickly. The unemployment rate also fell back to 3.7%. There were job gains for the health care sector, government, social care, and construction. Job gains in these areas suggest that the US economy is doing well, and these areas do not tend to hire temporary workers, especially during holiday season. The number of workers in the leisure and hospitality sector and the retail trade sector was fairly consistent with November, which also suggest that the increase in US jobs last month is not just due to temporary holiday hires. This supports the view that there is an underlying strength in the US economy, which is something that the Fed will need to watch closely in the coming months.

What next for the S&P 500

Overall, today’s labour market report makes it likely that the S&P 500 will end its 9-week winning streak, as it is currently lower by 0.34%. The US blue chip index is now down by more than 2% so far this week, while the Nasdaq is down by more than 4% after some of the biggest tech names took a battering. Apple is down by 6% so far this week, after Barclays analysts downgraded the stock to a sell on the back of expected weakness in iPhone sales this year, while Tesla is down nearly 10%. Since the IT sector makes up nearly 30% of the S&P 500, weakness for tech can have a very large impact on the direction of the overall index.

Interestingly, a 9-week winning streak is a very rare event and has only happened 4 times in the last 50 years! Thus, a pull back is to be expected, and just because we see a couple of weeks of higher volatility and weaker stock market returns, it does not mean that stocks are doomed for the rest of the year. It is worth noting that Friday’s labour market data is still consistent with the “soft economic landing” narrative, which should be good for US stocks, which are sensitive to the development of the US domestic economy, even if the IT sector is less sensitive.

EUR and inflation data

Elsewhere, the euro is down 1% so far this week as the dollar makes a comeback and rises alongside US bond yields. The 2-year Treasury yield is higher by 17 basis points so far this week, thus the bond market volatility that we saw last autumn may rear its head once more. The Eurozone has had some mixed data this week, with German retail sales for November falling sharply, yet German inflation data released earlier this week was stronger than November last month, rising to 3.8% from 2.3%, due to the base effects of energy prices. This led to some upward pressure on the headline Eurozone CPI rate for December, which rose to 2.9% YoY from 2.4%, however, the core annual CPI growth rate followed its downward trend, falling to 3.4% from 3.6% in November, which has added to the downward pressure on the euro this week.

FOMC minutes: Key takeaways

The FOMC meeting minutes were well worth a read. The key takeaways were that the Fed still thinks that inflation risks remain skewed to the upside, real GDP growth is slowing, credit quality in the US is broadly stable with some sectors like credit cards and small business loans seeing their delinquency rates move higher in recent months. Reducing the Fed’s balance sheet remains a top priority for the Fed, which means QT is back on at the same time as the Fed thinks that the risks to their inflation forecast are to the upside, while the risks to their growth forecasts are to the downside. The Fed’s next move is thus unknowable at this stage as the Fed remains data dependent. Next week’s CPI data could make their next move clearer and bring us either closer or further away from a March rate cut.