Yields Surge on “Stagflationary” PMI Data

The second quarter of 2024 got off to a shaky start for U.S. stocks on Monday, with the S&P 500 falling 0.4% and the Dow Jones Industrial Average dropping 0.7%. The tech-heavy Nasdaq Composite dipped below the flatline, erasing earlier session gains.

Despite the lackluster start to Q2, Wall Street has had an impressive run in 2024, with the benchmark S&P 500 setting 22 fresh closing records so far this year as part of its best first quarter since 2019. All three major averages have now risen for five consecutive months.

While markets were closed on Friday, the week’s data highlight – the Personal Consumption Expenditures (PCE) price index – fueled hopes of potential rate cuts later this year. The PCE index, which contains the Fed’s preferred inflation gauge, “core” PCE, showed a 0.3% month-over-month increase, falling short of economist expectations. Fed Chair Jerome Powell remarked that the data was “along the lines” of what the central bank is looking for.

The PCE report initially bolstered investor bets on a June rate cut, with the CME FedWatch tool indicating that around two-thirds of investors were pricing in a cut at the Fed’s June meeting as of this morning, up from about 55% last Thursday.

Treasury yields then skyrocketed higher, though, while rate-cut odds tumbled following the resurgent ‘price’ data in today’s PMIs. The odds of a June rate dropped back to just 50%, down from Thursday’s 55% and well below the 75% peak from last week, as the bond market reacts to the latest economic data.

The surge in Treasury yields is putting pressure on stocks, a change from the recent trend where equities have been largely immune to the bond market’s movements.

‘Hard’ data has been soaring since the start of the year, even as ‘soft’ data has collapsed. All eyes are on this morning’s Manufacturing PMIs (surveys) to see if this trend will continue.

ISM’s Manufacturing PMI surprised to the upside, rising from 47.8 to 50.3, better than the 48.4 expected and breaking a 15-month streak below 50. However, S&P Global’s US Manufacturing PMI disappointed, falling from its ‘flash’ print of 52.5 to 51.9, also down from the final print of 52.2 in February.

Despite the mixed results, both surveys highlighted a common theme: soaring prices. S&P Global noted that higher oil and raw material costs, along with increased transportation rates, added to cost burdens at the end of the first quarter. The impact of rising labor costs was also mentioned as a factor pushing up selling prices at a number of manufacturers.

Employment remains in contraction for the sixth straight month, while the Prices Paid index surged to its highest level since July 2022, indicating that inflationary pressures are far from subdued.

While the upturn in manufacturing is encouraging, it comes at a cost. The broadening of the upturn from services to manufacturing and the reviving demand for goods have driven the fastest increase in factory production since May 2022. Jobs growth has also picked up as firms boost capacity to meet demand, and rising capex spending has buoyed orders for machinery and equipment, signaling growing confidence in the outlook.

This uptick is also being accompanied by some strengthening of pricing power, with average selling prices charged by producers rising at the fastest rate in 11 months as factories pass higher costs on to customers. The rate of inflation is running well above the average recorded prior to the pandemic, with a particularly steep rise in prices charged for consumer goods, which rose at a pace not seen for 16 months. This underscores the likely bumpy path in bringing inflation down to the Fed’s 2% target.

The combination of slower growth and much faster inflation does not bode well for the prospect of rate cuts. In fact, it suggests that the Fed may need to maintain a tighter monetary policy stance for longer than currently anticipated by the market.


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