Fed Hawks Progress on Strong Data, Oil Jumps

The US economy made a surprising leap in December, adding over 250,000 new nonfarm jobs. This figure is around 90,000 more than what analysts had predicted, and the unemployment rate dropped to 4.1%. For those who follow the Federal Reserve closely, there's a slight silver lining: annual wage growth eased from 4% to 3.9%. Nevertheless, the overall job report paints a very robust picture of the economy. This positive data is good news for President Joe Biden, who will hand over a resilient economy to his successor. However, it poses challenges for the financial markets, as such strong job numbers have led to diminished expectations for a dovish stance from the Fed.

As a result of the strong job report, yields on US Treasury bonds surged. The 2-year yield, which reflects market expectations for Fed interest rates, rose to 4.40%, marking its highest point since November. The 10-year yield also spiked, reaching 4.78%, the highest since October, while the 30-year yield hit 5%. Following the release of this economic data, the probability of the Fed not cutting rates in May jumped to 67%, and the chance of a rate cut in June has become nearly a toss-up.

The reaction of the stock market was notably negative, as expectations for rate cuts faded. The S&P 500 index fell over 1.5% on Friday, ending just above its 100-day moving average. Similarly, the Nasdaq 100 opened with a gap below its 50-day average and lost a comparable amount. The Dow Jones Industrial Average dipped 1.63%, while small-cap stocks plunged more than 2%. The rising yields and prospects for prolonged higher rates have raised concerns for stock valuations.

Moreover, the steepening yield curve poses additional danger to stock prices. Typically, when long-term yields increase more rapidly than short-term rates, it indicates inflationary pressures or tightening of financial conditions, both of which can hurt stocks. As the new week begins, market sentiment remains fragile, with the VIX index inching closer to the 20 mark.

Looking Ahead

This week, upcoming inflation data will be released, which could further shape the market's expectations. Tomorrow, the Producer Price Index (PPI) is anticipated to show a decrease in price growth from 3.4% to 3.2% for December. Meanwhile, the Consumer Price Index (CPI) data due Wednesday is expected to report an increase in headline inflation, rising from 2.7% to 2.9%. Core inflation is also predicted to remain stubbornly above 3%. If inflation data comes in strong, it could completely undermine the forecast of a rate cut in June, leaving stock investors reliant on earnings to sustain market values.

On the earnings front, major US banks are set to kick off reporting this week. Firms like JP Morgan, Wells Fargo, Goldman Sachs, and Citigroup will reveal their results on Wednesday, while Bank of America and Morgan Stanley will follow on Thursday. Additionally, Taiwan Semiconductor Manufacturing Company (TSMC) is also reporting its Q4 earnings on Thursday. Expectations for TSMC are high, especially since its fourth-quarter sales rose by 39% to approximately $26.3 billion, surpassing estimates. This data suggests that spending in artificial intelligence is set to continue into the new year. Despite overall market turmoil, TSMC shares edged up slightly by 0.60% on Friday, while Nvidia's shares fell by 3%.

When considering the financial sector, bank stocks in the S&P 500 rose by 40% last year and have maintained a 28% increase compared to the beginning of last year. The current high-interest rates, particularly with a steep yield curve, have allowed banks to benefit from increased net interest revenue. Alongside strong trading activity, banks are forecasted to achieve nearly a 40% increase in their quarterly earnings. For instance, regional banks are expected to report a profit of $3.1 billion, compared to a loss of $3.8 billion from the same quarter last year.

In broad terms, the S&P 500 companies anticipate an 11.7% growth in earnings for Q4 of 2024. Notably, Factset indicates that year-over-year earnings could exceed 14% for the fourth quarter based on averages from the earnings season. If this outlook is accurate, a stronger-than-expected earnings report could buffer against a potential sell-off in US stocks, although the negative Fed expectations continue to present a significant risk to this optimistic view.

Market Movements: FX and Energy

The US dollar began the week on a strong note, with the EUR/USD pair testing the 1.02 support level. This test is occurring amidst a general strengthening of the dollar fueled by rising hawkish sentiment regarding future Fed actions.

In the energy sector, US crude prices made significant gains, trading above the $78 per barrel mark—the highest level since October. This surge follows the announcement of important sanctions by the US and the UK against two major Russian oil firms, which together exported nearly 1 million barrels per day in the first ten months of 2024—approximately 30% of Russia’s total tanker flows. Additionally, the US sanctioned over 180 vessels connected to Russia’s shadow fleet, effectively doubling the number of oil tankers targeted. Such measures are expected to counteract the projected 1 million barrels per day surplus for oil in 2024, per IEA forecasts. Although crude prices have increased rapidly, leading to the Relative Strength Index (RSI) entering overbought territory, the short-term outlook remains positive. Thus, there may be further testing of the $80 price level as the rally continues. Any price pullbacks could present opportunities for traders looking to strengthen long positions. However, the medium-term sentiment regarding oil remains mixed, mainly due to an uncertain global economic outlook, particularly in China, with strong resistance identified near the $80 psychological level.

economy, jobs, inflation, markets, oil