Can you believe that we’re halfway through 2024 this Friday? So far, it’s been a tale of 2 quarters for markets (and macro).
In Q1, a strong economy boosted equities but also inflation, pushing up rates
In Q1, equities and bond yields rose together.
- The Nasdaq-100 gained +8% (chart below, blue line), while
- 10-year Treasury yields rose over 30bps to 4.2% (black line).
Back in April, we looked at why equities and bond yields had moved together. In short, the economy had outperformed expectations, and a strong economy helped companies (boosting equities), but it also added upward pressure to inflation (making rates rise).
In Q2, rates mattered to stocks
In Q2, things were almost the opposite. Every time rates went up, stocks fell – and vice versa.
To start the quarter off, economic data stayed strong (green text), pushing 10-year yields all the way to 4.7%. By that point, higher rates started to become a drag on equities, with the Nasdaq-100 selling off to start the quarter.
But then the economy hit an inflection point in late April, and data started coming in softer (red text). We’ve seen:
- Cooling inflation: CPI and PCE inflation have finally started to slow again after rising throughout Q1, and producer prices are slowing too.
- Softening labor data: We got a relatively “soft” jobs report in May, and we’ve started to see jobless claims turn up modestly from historically low levels.
- Consumer spending slowing: Excess savings are mostly gone (especially for lower-income households), real wage growth has eased (but stayed positive), and higher rates are weighing on big-ticket purchases that require financing.
- Small businesses facing margin pressure: Worsening pricing power and increased borrowing costs has crimped margins, resulting in easing hiring plans.
A cooling economy led markets to price more rate cuts (later), boosting stocks
With inflation still sticky and employment still strong, the timing of the first rate cut keeps getting pushed out (the orange line starts above the grey line).
But the softer data has increased expected Fed rate cuts (in 2025). Now, markets expect rates to fall to almost 4% by the end of next year. That’s 45bps lower than in late April, which helped the Nasdaq-100 to rally. It’s now +17% YTD.
In short, in Q2 rates started to matter to stocks. But since markets saw some signs of slowing, that helped rates to fall, and helped stocks to rise.
In fact, markets have already hit year-end targets set by many economists back in January. Some expect the good (soft landing) news to continue, with some re-upping their forecasts. For example, Goldman now expect the S&P 500 to rise another 2½% from here to December, while Evercore see a 10% gain.
But with the Fed now running late on rate cuts, we’ll have to see if they can manage the soft landing markets expect.
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