U.S. Economic Slowdown: Rate Relief Impact on Stocks

Key Points:

• Investors navigate macro data, FOMC minutes, and earnings.
• Retail sales fall, suggesting economic slowdown.
• China’s property market experiences price rebound.
• Dollar depreciation raises questions in FX markets.
• Oil market stability hinges on China’s economic recovery.

MARKETS

The first week of April kick-started a relatively heavy stretch of price discovery as investors navigated month-end/start-of-month macro data, FOMC meeting minutes, and the 1Q23 earnings season.

Stocks continue to trade well as investors assessed an expanding body of evidence suggesting the world’s largest economy is finally beginning to cool; hence the prospect of a Fed pause continues to attract investors of all stripes who believe that rate relief, even if only a break later in the year, could be a bigger benefit than a small growth hit to the most advantaged high-tech stocks in the world that dominate moves at the S&P 500 index level.

Retail sales have fallen in four of the last five months. This suggests that January’s much-discussed surge, the largest since the last round of stimulus checks, now stands out as a mild weather-related anomaly. And while the US consumer wasn’t in the best spirits last month, given the banking tumult in March, one could argue that the US consumer held up better than feared.

One month after SVB’s collapse, the risk of a disruptive broadening of banking system stress has receded, and the potential impact of the turmoil is becoming less uncertain.

So we could be reaching that policy fork again where investors acknowledge some amount of easing should be priced late in the cycle, but with hard economic data still holding up, inflation as sticky as usual, and banking fears receding; hence there could be too much easing discounted at the front end of the curve, especially with “recession imminent” calls getting pushed out.

It is also worth noting that while Fed officials were understandably concerned about the bank crisis in March, most of the commentary since then has at least noted that the tightening in lending conditions appears mild so far.

CHINA

The National Bureau of Statistics’ 70-city house price data suggests the weighted average property price in the primary market rose sequentially in March after seasonal adjustments.

The increase in house prices was broad-based among all city tiers. The proportion of 70 cities that experienced sequentially higher property prices rose further in primary and secondary markets. After falling for 18 straight months, prices finally rose in February.

So with the second month of home-price inflation in the book, the uptrend should bolster consumer confidence as credit easing and policy support are trickling down to the real economy.

The focus will be on 1Q GDP this week. Given the strong activity data, it could print higher than the consensus forecast of 3.8%, reinforcing the expectation of no further easing by the PBoC amid a strong credit impulse, despite low inflation.

China’s recovery thus far has largely followed its typical trends: leading indicators such as credit impulse and PMI rebound first, while inflation and consumer consumption are often the last to move. Consumer sentiment will likely recover later when job market conditions have tightened and income growth has improved.

FOREX

While the recent Dollar depreciation is understandable given the below consensus US soft data run, however with the hard data holding up fine, the proportion of divergence being priced in FX markets looks exposed. Risk markets are pricing a relatively slight slowdown, but rates traders are perhaps factoring too much accommodative Fed policy too soon; hence FX traders could hit a fork in the road before too long.

Last week’s H.4.1 report showed that total borrowing from the Fed continued to decline, with the BTFP responsible for a larger share of the overall lending, which is a positive sign. Flows into money market funds have also slowed, suggesting severe deposit outflows have somewhat softened.

Friday’s H.8 report also showed that small bank deposit outflows have, for now, stabilized. However, money market fund yields will remain an attractive option to overnight bank deposits, which could lead to further deposit losses and force banks to pay up to keep deposits. Lending also appeared reasonably stable while not exactly robust.

Stability in the banks matters for the dollar because, as Fed Governor Waller said last week, they have been focused on tightening credit conditions via the price of credit. This substitution is harmful to the dollar, all else equal. Undoubtedly this is the most significant variable for currency markets over the short term; hence if the US terms of credit change negatively, then the Fed would not have to increase the policy rate by as much, and the dollar would weaken further.

OIL 

The mission was accomplished if OPEC desired to inject price stability into the market, with volatility at an 18-month low.

The market is struggling to assess the medium-term outlook for the global economy and oil demand, with the majority of bullish views over-reliant on China to carry the baton. Improving property markets should help the view, but much skepticism remains about the recovery.

Typically a buy signal for oil markets, a stronger Yuan on Friday, failed to inspire the price bounce that we had expected.

Russian oil flow appears uninterrupted so far this year. Indian refiners have been buying record amounts of Russian crude.

China continues to export sizable amounts of refined fuels.

It could lead one to believe that the post-OPEC price spike could be the peak for the quarter, absent a supply shock or demand picks up in aviation fuel in China.

Oil markets will focus on China’s GDP this week, where there is a good chance it could come in higher than the consensus.