Rising Treasury yields, falling oil prices, and hawkish talk from the Fed

A rising 10-year US Treasury yield, falling oil prices, eurozone disinflation, and some strong US economic data top my list of notable items impacting markets and investors over the past week. Here’s what I’m watching at the moment, including talk from central bankers about interest rates.

Hawkish talk grows louder from US central bankers

Last week, the 10-year US Treasury yield rose to levels not seen since last November.¹ The catalyst was the higher-than-expected US Consumer Price Index (CPI) print several weeks ago, which caused markets to change their collective mind about Federal Reserve (Fed) policy this year. That view was reinforced by last week’s retail sales report, which rose well above expectations², as well as hawkish Fed speak from a cast of Federal Open Market Committee members. A few highlights from the past week:

• From Fed Vice Chair Philip Jefferson: “…if incoming data suggest that inflation is more persistent than I currently expect it to be, it will be appropriate to hold in place the current restrictive stance of policy for longer. I am fully committed to getting inflation back to 2%.”³
• From Fed Chair Jay Powell: “The recent data have clearly not given us greater confidence and instead indicate that it’s likely to take longer than expected to achieve that confidence. Right now, given the strength of the labour market and progress on inflation so far, it’s appropriate to allow restrictive policy further time to work and let the data and the evolving outlook guide us. If higher inflation does persist, we can maintain the current level of restriction for as long as needed. ”⁴                                                              
• From New York Fed President John Williams: “We’ve got interest rates in a place that is moving us gradually to our goals, so I definitely don’t feel the urgency to cut interest rates.”⁵    
• From the Federal Reserve Financial Stability Report released last week: “The risk of persistent inflationary pressures leading to a more restrictive than expected monetary policy stance remained the most frequently cited risk, mentioned by nearly three-fourths of survey participants. The share of survey participants mentioning policy uncertainty as a risk to the financial system stood at just under two-thirds, significantly higher than in the October report.”⁶

Oil prices fall despite Middle East tensions

Prices for West Texas Intermediate crude oil actually fell last week from recent highs.⁷ That was a head scratcher for some given the high tensions in the Middle East, but I think it reflects a few key factors:

• First of all, US oil production has been a game changer in terms of softening the impact of Middle East geopolitical risks on the price of oil. According to the US Energy Information Administration, the US has been the largest producer of crude oil since 2018. Its 2023 production of 12.9 million barrels per day was far higher than the second-largest oil producer, Russia, at 10.1 million barrels per day, and Saudi Arabia at 9.7 million barrels per day.⁸
• In addition, while Middle East tensions are high, they are not as high as many feared. The measured responses between Iran and Israel have been performative in my opinion – they are very controlled, intending to show displeasure with the previous act of aggression but seemingly designed to avoid escalation in military actions.
• Also, the new conventional wisdom that rates will be higher for longer is expected to cause some level of demand destruction, which I believe has exerted some downside pressure on oil prices as well.

Hope continues for more rapid disinflation in the UK

The most recent UK CPI print supported the thesis that UK inflation will remain sticky. Services inflation eased, but not as much as market watchers would have liked. In addition, UK wage growth has also slowed less than expected. This caused markets to change their collective mind on when the first Bank of England rate cut will occur.

I, however, hold out hope for a rate cut before the end of the second quarter. As such, I took comfort from the words of Bank of England Deputy Governor David Ramsden, who said: “Given we know the level of the Ofgem price cap for April and also taking account of the freezing of fuel duties in the March Budget, then other things equal we can be confident headline CPI inflation will fall sharply in April, to close to the 2% target.”⁹ The significant increase in unemployment in the UK from 3.9% in January to 4.2% in February¹⁰ helps make the case for easing sooner rather than later, in my opinion.                                                             

The eurozone makes significant progress with disinflation

Eurozone year-over-year inflation for March was 2.4%, down from 2.6% in February and 2.8% in January. This is impressive progress considering that a year ago, the inflation rate was 6.9% year over year. Core inflation, excluding food and energy, was also unrevised at 2.9% year-over-year for March — and excluding tobacco as well was 2.6%.¹¹ In my view, this trend virtually ensures that the European Central Bank will enact a rate cut at its June meeting.

The US economy appears strong, but small consumer headwinds are appearing

A substantial amount of data supports the view that the US economy is quite strong. Just look at last week’s US retail sales report, which followed a slew of relatively strong data. This is reflected in high yield spreads, which have actually tightened in the last several months. They are well below the 30-year average spread of 4.93% – and far below the 7.5% level that has historically coincided with recessions.¹²

However, some data suggests consumers – at least lower income households – are starting to experience some headwinds. For example, US credit card delinquencies in the fourth quarter reached their highest levels since the Philadelphia Fed started tracking this data in 2012.¹³ And the share of accounts making minimum payments rose 34 basis points to a data series high from last quarter’s reading, indicating increased income stress.¹⁴

Some credit-card issuing banks are more exposed to rising delinquency rates than others, and we’ve already seen the issue of delinquencies show up in the earnings call of one lender who has more exposure to lower income American households. We will want to follow this closely. Any significant rise in unemployment could have a corresponding impact on lower income households, especially given the low level of savings they have – which means they lack a buffer against economic headwinds if they increase. This is not my base case, but we need to resist complacency in our views, so following the health of the consumer closely is important.

News from China and Canada

It’s also worth noting that China’s gross domestic product print for the first quarter positively surprised, coming in above expectations. This suggests targeted fiscal stimulus is improving confidence and having a beneficial impact on the economy.

Meanwhile, Canada’s federal budget for 2024 was released last week. While there are some interesting proposals that could boost economic growth, and help increase household financial stability, it also raises concerns about government debt and the high cost to service that debt – although not nearly as significant as the concerns being articulated south of the border in the US. For more information on the federal budget, please see our commentary here: Federal Budget 2024 – What you need to know

Asset class implications

Risk assets are clearly under pressure and likely will continue to be with higher yields. However, I believe this too will pass. I still believe a Fed rate cut in June and a total of three rate cuts for the year are very real possibilities.  But markets likely won’t change their minds – and therefore pressure likely won’t come off risk assets — until there is significant data that shows more disinflationary progress and a “less hot” economy.

When I think about my hopes for upcoming data, I am reminded of something that Antonio Salieri, the rival of Wolfgang Amadeus Mozart, supposedly proclaimed (at least in the movies), “I speak for all mediocrities. I am their champion ... I am the patron saint of mediocrity.” Well, we could have used some Salieri-type CPI and retail sales data in the last few weeks. And I am hoping for some Salieri moments for US economic data in coming weeks and months – mediocre inflation data, and economic data in general, that doesn’t surprise to the upside.

There is reason for optimism once we get more evidence of the US’ disinflationary trend. I think the pullback we have experienced is healthy, and it renders valuations on risk assets more attractive. And there is still significant cash on the sidelines that could move into markets. In fact, a comment in an earnings call last week from the chief financial officer of a major global bank supports this view: “...there's a lot of cash at this point. So that would tell you it's supporting the ability to see continued assets under management flows going forward, depending on how the -- obviously, the stock market shakes out over time. But we're all struck by just the sheer amount of cash on the sidelines at this point.”¹⁵ I don’t think this is an anomaly; I suspect that many banks are seeing elevated levels of cash sitting on sidelines.

What to watch this week

The most critical data point in the coming week, in my opinion, will be US Personal Consumption Expenditures. Also important will be US gross domestic product and the University of Michigan consumer inflation expectations. Needless to say, I am hoping these will be “Salieri” data points — ones that are mediocre and do not surprise to the upside.

We also have the Bank of Japan (BOJ) decision this week. We have heard a lot from Governor Kazuo Ueda in recent days suggesting the BOJ will not be afraid to tighten monetary policy further if inflation keeps rising. A recent survey by Tsutomu Watanabe¹⁶ indicates that Japanese consumer inflation expectations have risen, which supports the view that higher inflation has legs. And so this central bank meeting could be important in terms of providing guidance on when the BOJ is likely to act again. This could be helpful in strengthening a very weak yen.

Also this week we have some important speeches from European Central Bank (ECB) members, including President Christine Lagarde. I expect continued messaging essentially confirming the start of rate cuts in June.

Finally, earnings season will be picking up steam. I look forward to the information gleaned on earnings calls for insights into industries, consumer and business behavior and the overall economy.