As inflation worsens, the "rate cut expectations" collapse, will the rise in US stocks come to a sudden halt?

Inflation expectations resurge as the labor market heats up, seemingly supporting the view that the "Fed is not in a hurry to cut interest rates", with market expectations for rate cuts continuing to decline.

Last week, international oil prices surged and Fed officials made "hawkish comments", causing the three major US stock indexes to briefly plummet by over 1% intraday, with the "fear index" VIX soaring to a yearly high. This week, the US stock market will face two major tests:

1. If the inflation data for March, to be released on Wednesday, exceeds expectations again, combined with last week's strong employment report, it will put pressure on the US stock market.

2. The first quarter earnings season for US stocks will kick off this week, and investors will also focus on whether companies' profit capabilities and prospects can support the current high valuations. Data shows that Wall Street strategists are not optimistic about the performance of US stock companies in the first quarter, with the profit growth of S&P 500 index component companies expected to be the lowest since 2019, at only 3.9%.

Since the beginning of this year, Wall Street's rate cut expectations have dropped from 7 times to 3 times, and now, this number may further decrease. Many economists warn that there may not be any rate cuts this year.

CME FedWatch Tool shows that the market's probability of the Fed's first rate cut in June has dropped from 55.2% a week ago to 50.8%. Pricing in the swap contract market indicates that traders expect the first rate cut to be in September.

Although economists' expectations for rate cuts this year are declining, the upward trend of the US stock market has not stopped, with the S&P 500 index rising by over 10% in the first quarter. Analysts point out that while lower interest rates theoretically benefit stock prices, in the long run, what ultimately drives stock price increases is corporate profit growth: Strong economic and consumer data indicate market expectations for future profits, helping to drive the stock market up.

Dashed Expectations for Easing

Strong economic data and the latest statements from Fed officials have dashed expectations for a rate cut in June.

Minneapolis Fed President Kashkari said on Thursday that the Fed may not even cut rates this year, and Fed Governor Bowman, who has permanent voting rights on the FOMC, said on Friday that it may be necessary to raise rates to control inflation.

Bowman stated that there are some potential upside risks to US inflation, and policymakers need to be cautious not to loosen monetary policy too quickly, and may even need to raise rates to control inflation.

Affected by the above factors, US bonds further declined, with the yield on the 10-year US Treasury breaking above 4.4%, reigniting inflation trades. Multiple Wall Street insiders predict that the 10-year US Treasury yield will rise to above 4.5% in the near term, and once it reaches 5%, it is likely to trigger a correction in the US stock market The CPI report released this Wednesday is seen as the next key point in determining the trend of US bond yields.

Investment banks generally believe that inflationary pressures in the United States in March have not eased. With the sharp rise in commodity prices, it is expected that the year-on-year increase in March CPI will rebound from 3.2% last month to 3.5%, while the month-on-month growth rate will slightly slow down from 0.4% to 0.3%; the core CPI year-on-year growth rate will decrease from 3.8% to 3.7%.

Analysts point out that the year-on-year increase in energy in March CPI continues to rise, with Brent crude oil futures prices hitting $90 per barrel for the first time since October last year, surging 18% since the beginning of this year.

In addition, prices of other raw materials such as copper, aluminum, and cocoa are also rising significantly. The increase in housing-related items, insurance costs, and investment management fees will also lead to a rebound in super-core inflation data. It may be unlikely to see inflation fall to the target level of the Federal Reserve in the short term.

Market Volatility May Rise

The surge in international oil prices and hawkish comments from Federal Reserve officials caused the three major US stock indexes to briefly plummet by more than 1% intraday, leading to the "fear index" VIX soaring to a yearly high.

Lauren Goodwin, economist and chief investment strategist at New York Life Investments, believes that for the future trend of US stocks, if market expectations of interest rate cuts further weaken, it may trigger more problems. The actual start of interest rate cuts by the Federal Reserve this year is a very important market signal:

Based on conversations with clients, borrowers with floating rates are eagerly anticipating a rate cut, hoping to benefit from refinancing. If the possibility of a rate cut decreases, these borrowers will face increasing challenges, which will affect their business decisions, including hiring and so on.

However, Nancy Tengler, CEO and CIO of Laffer Tengler Investments, believes that the stock market still has room to continue rising in 2024, and the future upward path will not be entirely influenced by the number of interest rate cuts by the Federal Reserve:

The current situation is similar to the "Greenspan era" of the 1990s, where the Federal Reserve may adopt a strategy similar to "maintaining high rates for a long time" to boost productivity to curb inflation, especially with the continuous advancement of artificial intelligence technology.

Nancy Tengler believes that the Federal Reserve is most likely to cut interest rates once in 2024, but this will not affect the trend of US stocks.

Billionaire investor and founder of Fisher Investments, Ken Fisher, believes that employment data has fueled investors' optimism about economic growth prospects, and the increasing popularity of AI has also improved corporate efficiency, indicating that even with high Federal Reserve rates, stock prices may continue to rise.

The first quarter earnings season for US stocks will kick off this week, with JPMorgan Chase, Citigroup, and Wells Fargo among the first to report on Friday. In addition to macroeconomic factors, investors will also focus on whether companies' earnings and prospects can support the current high valuations. **

Wall Street strategists are not optimistic about the performance of US stock companies in the first quarter. Data shows that the profit growth rate of S&P 500 index component companies in the first quarter is expected to be 3.9% year-on-year, hitting the lowest level since 2019.

According to FactSet data, the first quarter earnings per share of S&P 500 is expected to increase by 3.2% year-on-year, potentially achieving positive growth for three consecutive quarters