Stocks surged in Q1 2024 across a variety of sectors, and earnings season will soon test the breadth of that rally. Last week’s CPI report on inflation is confirming that interest rates may indeed remain higher for longer as the bond markets have been suggesting. Inflation as measured by CPI, rose by 3.5% in March, higher than expectations, and signaling an acceleration of inflation. Without food and energy, inflation is now at 3.8%, while shelter was up 5.7%, and electricity was up 5%. This was the third time in as many months that the CPI was higher than expected.
It is most likely high interest rates that are causing shelter prices to spike, because so many homeowners are locked into low-rate mortgages, which reduces the supply of homes. This, plus high current mortgage rates, makes housing for new homeowners unaffordable, so they drive up demand for rental properties.
As a result of this adjustment in the inflation outlook, last week’s US treasury bond auction of $39 billion was received poorly, sending yields on 10-year treasury bonds to 4.64%, up from 4% in January. 30-year mortgage rates are now approaching 7% again. For the bond market, higher rates for longer seems to be the current forecast. Recent remarks by Fed officials have driven Wall Street to pare bets that the Fed will start lowering interest rates in June, with the futures market, reflecting that the probability for interest rate cut this year is diminishing.
Oil and commodity prices have been rising since mid-December, continuing to pressure inflationary forces. Recent attacks by Iran on Israel have exacerbated this trend.
Nonetheless, consumption remains very strong in the US economy, defying forecasts that post pandemic spending would soften and that student loan paybacks, and/or record credit card interest payments, would cause a softening in spending. Real consumer spending is growing faster than its average over the past fifty years, and retail sales in the first quarter, comprising a full one-third of all consumer spending, rose sharply, diminishing any expectations over an economic slowdown.
The unemployment rate remains historically low under 4%. Real capital spending is also strong, particularly on software and manufacturing infrastructure, and is being financed by a record $3.5 trillion dollars in corporate cash flow. Fiscal policy remains stimulative, particularly with respect to public infrastructure spending and incentives to “re-shore” manufacturing from abroad.
Geopolitical risks are heightening, with escalating tensions between Iran and Israel reaching new heights. Iran’s bombardment of Israel caused market jitters on April 12th over concerns about oil prices. If there is severe tension that arises in the Middle East, it is quite possible that oil and gold prices continue their upward trajectory. After a strong first quarter, it would not be surprising to see a near-term pullback in the stock market, although the continued resilience of the IU.S. consumer, strong employment, and the ongoing ability of U.S. businesses to grow earnings are all encouraging. S&P 500 earnings for the first quarter are expected to have grown by 5% and should be strong as nominal GDP growth is running close to 6% now.
The S&P 500 was up 10.01% in the first quarter, the Dow was up 5.6%, and the Nasdaq was up 10.9%.
