Markets

After a strong first quarter for risk assets, market bulls were expected to hold onto their lead going into the second quarter, helped along by encouraging data out of China and optimism surrounding the preferred price gauge that the Federal Reserve released late last week. For better or worse, this measure was thought to be adequate to calm inflation fears even in the face of recent overshoots in the Consumer Price Index (CPI).

But the biggest economy in the world, the United States, has released some very important facts. With a reading of 50.3, the ISM Manufacturing Purchasing Managers’ Index (PMI) exceeded forecasts and entered the expansion zone for the first time since late 2022. Although this good news was accompanied by a warning shot across the bow of the market on inflation, economists had predicted a reading of 48.3, which would have been the 17th consecutive contraction.

Although the increase in activity and demand is positive, manufacturers’ average selling prices increased at the highest rate in 11 months in March, signaling a strengthening of their pricing power. The internal economist at S&P Global noted that the consumer products industry is one where this price increase is very noteworthy. This development highlights the difficulties in bringing inflation down to the Federal Reserve’s target of 2% and contrasts with the upbeat tone of Friday’s Personal Consumption Expenditures (PCE) statistics.

The US manufacturing recession is finally over, which is fantastic news, but there’s a nasty inflation kicker.

It’s reasonable to believe that the “good news is bad news” trade has begun in Q2, given the Fed’s repeated insistence that they are not automatically cutting interest rates.

However, it’s crucial to avoid overanalyzing price activity on the opening day of a new month or quarter due to holiday-reduced trading. It’s important to note, though, that US rates have moved.

As a result of the implications of a shockingly strong report on America’s key manufacturing activity index, which entered growth territory for the first time since September 2022, US yields experienced a large spike across the curve into the US afternoon.

Although we continue to believe that the Fed is desperate to lower interest rates and is searching for an excuse, it is crucial to remember that the market-determined the front end of the yield curve through conjecture about potential policy changes. Therefore, even while the median dot plot marker for 2024 stayed the same in the dot plot redo from March, suggesting that three rate reductions are expected, at one point on Monday the market-implied probability of the first cut taking place in June fell below 50% for gamblers.

Because of the growing odds that the Fed will be late to the Central Bank rate-cutting party in June, the US dollar rose.

In the meantime, the price for the entire year dropped to just 66 basis points, which is practically “half a cut” lower than the median dot for 2024.

Nonetheless, a sequence of positive economic shocks would be necessary to substantially move market valuations in favor of the Fed’s more aggressive perspective. These shocks would probably have to do with overshoots in pay statistics or inflation. In the absence of such events, the market might calm down, thinking that the Fed is being rather dovish in an economy that is trying to operate at a warmer temperature than when it usually drops rates.

On Monday, stocks had a negative reaction. It’s important to remember that the pace of bond yield increases frequently matters more than their exact amount in terms of the correlation between rate hikes and stocks. A 10-basis-point increase in 10-year yields caused some stock market trepidation, as the market was already quite optimistic due to Q1’s strong performance and the Easter Egg sugar rush.

Markets For Oil

With the recent ISM report indicating the end of the protracted US manufacturing recession, which is considered as optimistic for oil demand, oil prices shot up to a five-month high. Oil futures saw ups and downs during the trading session, with support coming from OPEC+’s prolonged production cutbacks through the second quarter, even though demand growth was not assured.

In fact, at the beginning of April, manufacturing data from the two biggest economies in the world added to the confidence for economic expansion and supported oil prices even more. After 16 months of recession, manufacturing in the US increased for the first time since September 2022.