Rate Hike Concerns Cap Market Gains

U.S. markets closed Tuesday, June 25, somewhat mixed. The tech-heavy Nasdaq (US-TECH 100) and the S&P 500 were up 1.3% and 0.4%, respectively, as AI stocks gained traction again following Nvidia's (NVDA) rebound. On the other hand, the Dow Jones (USA 30) slipped 0.8%. 

Tuesday's gains appeared to have been capped by Fed officials signalling no haste to cut interest rates, which dampened expectations of aggressive rate cuts just ahead of Friday's U.S. Personal Consumption Expenditures (PCE) data. Moreover, Fed Governor Michelle Bowman indicated there is still a chance of further rate hikes if inflation does not come under control.

With June coming to a close, some traders might remain cautious about hopping onto the S&P 500 after its nearly 15% rally in the first half of 2024. In addition, the latest CB Consumer Confidence slipped to 100.4 in June from 101.3 the prior month, raising concerns. However, strategists still believe the recovery has more room to run, provided productivity increases boost growth in the coming months.  

Tech Sector Bounces, Leads Charge

Nvidia's stock reversed a three-day drop on Tuesday, boosting the S&P 500 and Nasdaq indexes higher after witnessing a correction led by a $430 billion loss in its market cap in recent days. This drove gains in the "Magnificent Seven" mega caps, with Carnival's (CCL) 8.7% being the only stock beating the AI darling. Notably, Alphabet (GOOG) notched to a record high after gaining 2.8%.

As for other stocks, FedEx (FDX), the company used by investors as a global economic sentiment indicator,  saw net income rise by 17% year-on-year and announced a $2.5 billion share buyback program for fiscal 2025. Still, Deutsche Bank (DBK.DE) analysts warn that positioning is near the top of its historical range, driven by tech, and risk appetite ahead of the earnings blackout period appears stretched. 

On the other hand, real estate and materials were the biggest drag, with housing and consumer stocks stumbling. (Source: Market Watch)

Fed's Hawkish Stance Caps Gains

Comments from Bowman on Tuesday, who backed more interest rate rises if inflation sticks at its current level, supported the U.S. dollar. With PCE inflation data coming up on Friday, the time for receiving further guidance is near as G7 counterparts have already begun their easing cycles.

Bowman said she remained "willing to raise borrowing costs again "should progress on inflation stall or even reverse. She said there remained "upside risks" to inflation that could stall further progress or even reaccelerate it.

Meanwhile, the remaining FOMC members think two cuts are likely, with several committee members saying that over the past week, there were signs the U.S. economy was weakening and price pressures dissipating. Fed governor Lisa Cook said that at some point, it would be necessary to cut rates "to maintain a healthy balance in the economy."

Rate Cut Expectations May Change 

At present, markets are forecasting a 25 basis point cut for the July 30-31 meeting at just 10% and for the September 17-18 meeting at 64%. Although the Fed is not expected to make any changes at its July meeting, if economic data trends positively, it may position itself for a potential rate cut in September. 

However, probabilities may change soon after the Fed's preferred measure of inflation—the PCE—provides more clarity. Core PCE is expected to fall from 2.8% to 2.6% and headline to 2.6% from 2.7% year-on-year, confirming the CPI trend.

Despite markets' expectation of 1-2 rate cuts this year starting in September, some experts argue against no rate cuts at all. The last strong U.S. jobs report on June 7 dampened expectations, and inflation still needs to cool further before any reductions take place. FOMC participants also project one or two rate cuts this year, down from three projected in March, assuming inflation moves substantially towards its 2% target.

Interestingly, the Fed has been quietly raising its estimates for the long-term "neutral" interest rate over the past six months, which refers to the interest rate that keeps the economy in balance without pushing inflation out of control. This suggests that the era of ultra-low interest rates in the long-term macro picture may be coming to an end.

Conclusion

Investors may wish to remain attuned to upcoming PCE inflation report and Fed communications for guidance around the timing of a potential cut. With mixed signals from various sectors and ongoing discussions ahead of the earnings blackout period, keeping a keen eye on such events may be crucial. The interplay between earnings surprises and economic data underlines the importance of caution in this active yet challenging market.