The start of 2023 has been a positive one for stock markets, with the exception of Japan, as market participants believe that the Federal Reserve will not have to raise interest rates as much as previously anticipated, and that the United States economy may experience a “soft landing.” The week began with a cautious attitude ahead of the Fed Chairman’s speech on Tuesday, but his words did not discourage market activity.
On Tuesday, Fed Chairman Jerome Powell delivered a speech in which he acknowledged the challenges facing the economy, including rising inflation. He stated that “…restoring price stability when inflation is high can require measures that are not popular in the short term as we raise rates to slow the economy.” However, Mr. Powell did not purposely kill the market’s rebound activity in his speech, which may have emboldened market participants.
The focus then shifted to the much-anticipated December Consumer Price Index (CPI) report, which was released on Thursday. The report showed continued disinflation in total CPI (from 7.1% year-over-year to 6.5%) and core CPI (from 6.0% year-over-year to 5.7%). These were good headline numbers, but it is worth noting that services inflation, which the Fed closely monitors, did not improve and rose to 7.5% year-over-year from 7.2% in November. Despite this, the stock and bond markets supported the view that the Fed will pause its rate hikes sooner rather than later.
The positive price action in US equities was particularly notable, with the S&P 500 closing above its 50-day moving average and up 4.4% from its low of 3,802 on January 5. The Fed funds futures market prices now indicate a 67.0% probability of the target range for the fed funds rate peaking at 4.75-5.00% in May, according to the CME FedWatch Tool. This is an increase from 55.2% a week ago.
When markets opened on Friday, market participants apparently decided to take some profits following the big run. Ahead of the open, Bank of America, JPMorgan Chase, Wells Fargo, and Citigroup reported mixed quarterly results relative to expectations that featured increased provisions for credit losses. Those stocks languished as did the broader market, but true to form so far in 2023, buyers returned and bought the dips. Before long the bank stocks were back in positive territory and the broader market.
The S&P 500 moved above its 200-day moving average (3,981) on the rebound trade and closed the week a whisker shy of 4,000. The U.S. Dollar Index fell 1.6% this week to 102.18. WTI crude oil futures made strides to the upside this week rising 8.5% to $80.06/bbl. Natural gas futures fell 4.8% to $3.23/mmbtu.
The recent string of better-than-expected news does argue against the potential of a deep global recession that economists have warned about. Mild weather has helped avert the energy crisis in Europe this winter, resulting in softer inflation. In fact, European equities have gained about 6% halfway through January, the best start to a year on record for the region and outperforming the U.S. market since September. At the same time, prospects for China’s economic growth have brightened, thanks to the reopening of borders as the country pivoted away from its zero-Covid-19 policy, together with measures to support the property market.
It is not yet clear if the bear market in equities is behind us, but the worst of inflation probably is. This means that central banks, especially the Fed, can afford to take their foot off the brakes soon, potentially relieving the upward pressure on bond yields and equity valuations. However, market participants should be aware of the potential danger of complacency as economic data improves. While the recent positive developments in the markets are encouraging, it is important to remember that the global economy is still recovering from the effects of the pandemic and there may be potential obstacles ahead.
Investors should also keep an eye on the ongoing stimulus talks in the United States, as any additional stimulus measures could have a significant impact on the markets. Additionally, the ongoing tensions between the United States and China, as well as the ongoing Brexit negotiations, also have the potential to cause volatility in the markets.
