The US blue chip index has not quite reached the 5,000 level at the time of writing, it is a mere 5 points away, but it seems inevitable that this key psychological level could be coming. The question now is what happens after this level is potentially breached? There is a bit of market nervousness around the 5,000 level and the index is fluctuating ahead of this level. The S&P 500 has rallied by more than 4.68% so far this year, easily outpacing European shares, and even performing better than the Nikkei on a YTD basis, so some fatigue around this key level is to be expected.
Earnings help to justify US stock market rally
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There has been good news regarding earnings. After a weak start to Q4 earnings season, largely because bank earnings disappointed, the outlook has brightened. There have been some notable outperformances from big oil, Disney, the tech giants and consumer discretionary like Uber, which has pushed Q4 earnings on aggregate for the S&P 500 into positive territory for last quarter. The earnings beat is widespread, which supports the rally in US stocks broadening beyond tech. However, while earnings reports are pulling their weight when it comes to boosting the S&P 500. However, there are some risk factors, including regional banks and their exposure to commercial property, Treasury auctions and Fed speak.
Beware Fed speak and the policy risk premium
There is a huge amount of Fed speak this week, and at this point in the monetary policy cycle – when we are on the precipice of change – it is incredibly important. The market learns of the Fed’s beliefs through policy speeches, and there are lots of those, especially from the Fed. Financial markets respond directly, not only to policy actions, but also in anticipation of them and through what they learn from speeches.
More Fed speakers urge caution on rate cuts
On Thursday, it was the turn of the head of the Richmond Fed, Tom Barkin, who said that regional bank lenders’ problems in commercial real estate won’t be enough to get the Fed to cut rates early. He also said that unless the economy turns south, the Fed won’t be jumping in with rate cuts. This has weighed on bond prices and has pushed up bond yields, the 10-year Treasury yield is higher by 3 basis points so far on Thursday. The market is still pricing in just under 5 rate cuts from the Fed, with the first cut still expected to come in May. However, this seems at odds with the fairly hawkish rhetoric that we have heard from Fed members this week. When the market disagrees with the Fed, it increases the chance of the ‘policy risk premium’. So, as we near a critical level in the S&P 500, the policy risk premium is increasing, and this is a risk for future gains in the S&P 500.
Interestingly, the Bloomberg Fed Speak Index, which uses AI to assess news headlines from Fed speakers, is still in dovish territory and is the most dovish since 2021. This is to be expected, as the Fed has said that they will cut rates this year. But we would point out that the US economy is posting positive economic surprises, and the Citi Economic Surprise Index is at its highest level since November 2023. Added to this, the Atlanta Fed GDPNow index is predicting Q1 growth of 4.2%, this is higher than the 3% estimate in January, and suggests that the pace of US growth is picking up and not slowing down as we move into the middle of Q1. This could cause Fed members to sound more hawkish, and we will be watching this index as we move forward.
Treasury auctions get bigger, but demand is strong for now
Elsewhere, there are some large US Treasury auctions coming up on Thursday, including $25bn of 30-year bonds. This is the largest amount in more than 2 years, however the market has been able to absorb hefty Treasury supply so far this week, so there is not much concern about the 30-year auction. On Wednesday, the US Treasury auctioned $42bn of 10-year bonds, which was a record size for a 10-year auction. However, the yield was lower than expected and demand was solid. With the Fed still expected to cut rates this year, the outlook for longer dated Treasury auctions remains strong, and we don’t see them as a risk factor for the market right now, even if the size of some of the auctions is eye watering.
Watch out for US CPI revisions
Economic data risk will increase from this Friday. The seasonally adjusted CPI revisions for the US are released on Friday and actual CPI for January is released next Tuesday. The revisions are worth watching because a year ago there was a large upward revision to US CPI, normally revisions are small. The Fed will also be watching to see if the disinflation trend is intact. These revisions, if they are large and to the upside, could blow the case for cutting rates. Last year’s revisions were an outlier, compared to the historical trend for small revisions, so there may be nothing to worry about. From a statistical standpoint, the chance of seeing a large upward revision two years in a row is low, but it is still worth watching. Upward revisions and stronger than expected CPI for January, could be enough to shift risk sentiment and halt the rally in the S&P 500.