US stocks decline as ADP's miss, and traders inch up bets of a Fed rate cut in March

The focus on Wednesday is firmly on the Federal Reserve meeting, even though there has been a large number of corporate earnings on both sides of the Atlantic. Ahead of the Fed decision at 1900 GMT, where interest rates are expected to remain at 5.25-5.5%, the market is increasing its bets on a rate cut in March. The probability of a 25bp rate cut in March is now 50.5%, according to the Fed Funds Futures market, last week there was just over a 40% chance of a rate cut. Interestingly, the market has trimmed bets on the overall number of rate cuts for this year, there are now just over 5.5 rate cuts priced in by the market, earlier this month, there were more than 6 rate cuts priced in.

Why Employment costs could make the Fed lean in to its dovish message

The Fed has a difficult decision to make. The economy is giving mixed signals. The ADP, private sector payrolls survey, was weaker than expected for January, with 107k jobs created, vs. expectations of 150k, and 164k in December. US 2-year Treasury yields have fallen by 6 basis points on the back of this data, however, it is worth remembering that ADP reports do not have a good track record of predicting payrolls numbers, so this does not mean that the US labour market is weak. For example, Tuesday’s JOLTS data showed higher than expected jobs openings for December, which suggests that the US labour market remains tight. Perhaps the most important number ahead of the FOMC meeting was the Employment Cost Index (ECI), which rose by 0.9% in Q4, down from the 1.1% increase in Q3. This is another sign of easing inflationary pressure in the US economy and suggests that this pace of employment costs is compatible with the Fed’s 2% inflation target. On an annual basis, the ECI was higher by 4.2%, the smallest annual advance since 2021, although it is still well above pre-pandemic levels. This is the Fed’s preferred measure of wage growth, and the downward trend should not stop them from cutting interest rates later this year.

The question now is whether the market is correct to be increasing bets on a March rate cut. US economic growth remains strong, and the Fed may still delay the first rate cut to the summer. If they do suggest a rate cut is likely in March, then we could see the dollar sell off. It has rallied versus 9 of the G10 currencies so far this month, so the buck could be vulnerable later on Wednesday.

Elsewhere, the euro, which has been under pressure since the start of the year, is staging a mini recovery ahead of the Fed meeting. The euro has ignored the weaker than expected German inflation data for January. The EU harmonized monthly rate fell by 0.2% this month, while the annual rate dropped to 3.1% from 3.8%, which supports ECB rate cuts.

Boeing stages a recovery, but for how long?

Corporate earnings have been a mixed bag this week. GSK shares are higher on Tuesday after it posted decent results and positive forward guidance, including a significant increase to its sales forecast. Boeing also posted good earnings for Q4, but it declined to give 2024 guidance as it focuses on addressing issues with lose bolts on panels of the Max 737 aircraft. Its shares are rising sharply on Wednesday, and are currently higher by more than 3%, erasing some of the 23% losses in January. If the incident with Alaska Airlines had not happened, then the Boeing was well placed to have a bumper 2024. Q4 earnings beat estimates and the company’s commercial aircraft division posted its first operating profit since 2019, when the Max 737 was grounded after two deadly crashes. Investors seem happy that Boeing is taking its problems seriously and focusing all of its attention on dealing with this issue, even if it means foregoing forward guidance. If the problem can be easily rectified, then there is no reason why Boeing cannot go on to have a successful 2024.

The Nasdaq falls sharply at the open

Elsewhere, the Fed decision could weigh on tech stocks going forward. The Nasdaq is down by more than 1% at the open, while Alphabet tumbles more than 6%, after it posted disappointing ad revenue for Q4. Microsoft posted a decent set of results; however, its share price has barely budged. There is a sense in the market that the Microsoft and Google earnings failed to live up to the high expectations around AI. Although Microsoft saw earnings and profits rise, its forward guidance was not particularly well received, particularly its guidance on 1-2% increases in operating margins in the coming years. AI is costing Microsoft a fortune, and this is eating into margins, investors haven’t warmed to this idea.

Has the AI bubble burst?

The AI bubble may have been partially burst on Tuesday night, as it reminded investors that AI will need significant and costly investment before it generates the revenues some had expected to come straight away. It’s a fascinating theme, and there is no doubt that it will lead the way in the third ‘industrial revolution’, however, it is going to take time. Investors notoriously get ahead of themselves, and this earnings season is bringing them back down to earth. The FOMC decision today could also knock tech stocks further. If the Fed signals that a March rate cut is likely, then it could help value stocks and cyclical stocks like airlines, consumer discretionary and other unloved sectors of the market recover at the expense of tech. This could also be positive for European stocks vs. US stocks, and it’s worth noting that the former are leading the latter for the second week in a row.