Not So Safe Havens Today

Today’s economic reports are nothing to celebrate unless you’re actively rooting for an economic slowdown.  The ADP Employment report missed by a wide margin, coming in at 145,000 when 210,000 was expected.  Last month’s number was revised higher by 19,000, but that still leaves us with a wide shortfall.  S&P Global Services and Composite PMI’s also missed, as did the ISM Service Index.  They were all above 50, but all were below both last month’s number and this month’s expectations.  On the positive side, ISM Prices Paid fell from 65.6 to 59.5, meaning that we might indeed be getting some disinflation.  

Yet even though the market welcomed the term “disinflation”, investors seem less enamored with the prospect of what might cause it to occur.

Today’s results fit in with a run of weaker data that we received earlier this week.  On Monday, Construction Spending and ISM Manufacturing came in light.  Yesterday brought a decline and miss in JOLTS Job Openings and Factory Orders, while Durable Goods came in at an as expected -1.0%.  None of this bodes well for the economic picture going forward.

In theory, this should be catnip for investors who are hoping for interest rate cuts.  If the Federal Reserve is indeed data-dependent, then this run of data might give them pause about hiking rates. Cleveland Fed President Mester commented today that she is unsure about whether another hike at May’s FOMC meeting would be required, though it is clear that she is still thinking that higher rates are more likely than lower rates in the near term.  In contrast, Fed Funds futures are currently pricing in a 40% probability for a rate hike in May and a likelihood of 3-4 cuts by the end of the year.

It is possible, if not likely, that investors are wrestling with a conundrum that we identified weeks ago:  equity investors crave accommodative monetary policies and the lower rates that accompany them, but have not fully reckoned with the conditions that might bring them about.   The Fed may pause their rate hikes, but they are not inclined to cut them unless dire circumstances require it.  As we have noted before, peak and pause do not mean pivot.

Federal Reserve muckety-mucks emphasize first and foremost that they are committed to fighting inflation even as they acknowledge the need for them to consider current economic data.  The FOMC was slow to pull the trigger on hiking rates and quantitative tightening when inflationary pressures became obvious.  Why should we expect that they will reverse course quickly?  We have noted that it is far more typical for the Fed to maintain rates at a peak for 6-12 months, rather than turn around and cut them quickly.  That last happened in 1995.  The peak is typically a plateau.  As before, we urge you to consider why the Fed might begin cutting rates and decide if those conditions would likely be positive for corporate America.

As I write this, just before midday, we see the S&P 500 (SPX) down by about 0.4% and the NASDAQ 100 (NDX) down by about 1.25%.  I was discussing this with a friend, and she noted that it seemed odd to see NDX acting so poorly even as yields are falling.  US 2-Year yields are down by 11 basis points and 10-years are 7bp lower.  If one of the key rationales for investing in tech stocks is that they benefit from lower rates and offering a safe haven in a rocky economy, then we would expect to see the megacap tech stocks providing ballast to key indices today.

But they aren’t.  It could be something as simple as recouping some of these stocks’ phenomenal outperformance during the latter part of the first quarter.  Yet even if the rotation out of megacap tech stocks is caused by relatively benign reasons, the outcome could be significant for the indices that rely on them.  We noted that this could pose a risk ahead of this month’s earnings season, and a spate of disappointing economic results may be indeed upping that risk.