Weekly global market focus
Trade tensions could worsen this week as NAFTA negotiations resume
Powell testimony could reset expectations for Fed policy
T-note yield remains stubbornly high
Stocks continue to struggle with stretched valuations
Weekly global market focus — The U.S. markets this week will focus on (1) Fed Chair Powell’s testimony to Congress on Tuesday and Thursday in the semi-annual monetary policy hearings, (2) the U.S. inflation situation with Thursday’s release of the Fed’s preferred inflation measure (Jan PCE deflator expected unchanged at +1.7% y/y and core expected unchanged at +1.5% y/y), (3) a full slate of U.S. economic reports during the week, (4) whether the 10-year T-note yield this week can remain below 3.00% with the Powell testimony and PCE deflator report, (5) whether the recovery in stocks can gather steam, and (6) whether crude oil prices can extend the 2-week recovery.
In Europe, the focus is on the February CPI reports and on politics ahead of this coming Sunday’s Italian election and the announcement of whether Social Democrats voted to approve a coalition with Chancellor Merkel’s CDU bloc. The markets are still not showing much concern about the Italian election even though the election is expected to produce a hung parliament. As long as the anti-EU Five Star Movement does not get into power, the markets will expect the established parties to muddle through without any threats to Eurozone cohesiveness.
In Asia, the focus will be on a full slate of Japanese economic reports on Wednesday and Thursday. In China, the markets are expecting the Feb PMI reports on Tuesday and Wednesday to show small declines.
Trade tensions could worsen this week as NAFTA negotiations resume — The markets will be carefully watching the new round of NAFTA negotiations, which began on Sunday and will last through next Monday. Negotiators have made some progress but President Trump continues to threaten that the U.S. may withdraw from the treaty, which would kick off a 6-month notification period. Negotiators have set a deadline of March for an agreement, but that looks very unlikely considering the difficult issues that still need to be resolved. The negotiations are already starting to run into the Mexican presidential election in July.
The markets will also be watching for any news on the Trump administration’s intention to slap tariffs on steel and aluminum imports. China’s top economic advisor Liu He will reportedly arrive in the U.S. on Tuesday to try to manage trade tensions with the U.S. Bloomberg reported last week that President Trump wants to put the harshest possible tariffs on U.S. steel and aluminum imports. That would well draw trade retaliation from China and perhaps other nations as well. China has been studying which retaliatory measures could do the most political damage to President Trump, with agriculture being a potential target.
Powell testimony could reset expectations for Fed policy — The markets are eagerly waiting to hear from Fed Chair Powell on Tuesday before the House Financial Services Committee and on Thursday before the Senate Banking Committee in the semi-annual monetary policy hearings. The markets have yet to hear much from Mr. Powell in his new role as Fed Chair and are eager to gauge his tone.
The markets are discounting a total of +69 bp worth of Fed rate hikes this year, which equates to 2.8 rate hikes. That is fairly close to the Fed-dot forecast for 3 rate hikes this year. However, there has been substantial market commentary about whether the Fed might need four rate hikes this year to address the strong economy and the pick-up in inflation. The market is discounting a 100% chance of a Fed rate hike at the next FOMC meeting on March 20-21.
T-note yield remains stubbornly high — The 10-year T-note yield last Friday fell by -5 bp to 2.87% and is now down by -8 bp from last Wednesday’s 4-year high of 2.95%. Still, T-note yields remain stubbornly high and the potential exists for new highs if Fed Chair Powell is particularly hawkish in his testimony this week or if Thursday’s PCE deflator report is strong.
U.S. inflation expectations remain near the recent highs with the upward rebound seen in crude oil prices seen in the past two weeks. The 10-year breakeven inflation expectations rate has rebounded higher in the past 1-1/2 weeks to 2.13%, which is just slightly below the 3-1/2 year high of 2.14% posted in early-Feb.
Stocks continue to struggle with stretched valuations — The 2-week upward rebound in the stock market stalled last week due to stretched valuations and continued worries about Fed policy and interest rates. The SPX forward P/E ratio last week rose to 17.6, which is up by 1 point from the correction low of 16.6, though still well below this year’s high of 18.8 posted in late-Jan.
The S&P 500 index last week closed mildly higher by 0.55%, near the middle of the early-Feb plunge. In a positive sign for stocks, however, the Nasdaq 100 index has been stronger and has retraced 85% of its early-February plunge, more than the 65% retracement by the S&P 500 index. The FANG stocks have seen an even stronger recovery with the Nymex FANG+ index last week easily rallying to a new record high.
There are only 32 of the S&P 500 companies that report earnings this week since Q4 earnings season is nearly over. Q4 earnings growth has been very strong at +15.3% (+13.1% ex-energy), which is stronger than expectations of +12.0% as of Jan 1. Of the 451 SPX companies that have reported, 76.5% reported above-consensus earnings, better than the long-term average of 63% and the 4-quarter average of 72%, according to Thomson I/B/E/S. Another encouraging development was that revenue growth was better than expected at +8.2% y/y. Of reporting SPX companies, 77.2% reported above-consensus revenue, much better than the long-term average of 60% and the 4-quarter average of 63%.