Stocks drop, bonds rise as Fed rate bets ease

Strong US economy could keep policymakers on the sidelines.

Stocks retreated and bond yields climbed on speculation the Federal Reserve will be in no rush to cut interest rates as the economy shows signs of resilience.

At a time when good economic news is not really that great from a policy perspective, a solid reading on retail sales fueled concern about Wall Street’s bold dovish bid. And with central bank officials recently striking a more cautious tone about prospects for easing, it ended up being the perfect recipe for traders to push back the timing for the first Fed move — assigning lower odds of a rate reduction in the first quarter.

“We will need to see data that is consistent with a still healthy and resilient consumer, but not to the point where the Fed would be inclined to delay rate cuts or cut less in 2024,” said Tom Essaye, a former Merrill Lynch trader who founded The Sevens Report newsletter.

Strong consumer spending helped propel the economy in recent weeks, the Fed said in its Beige Book survey. Bond traders abandoned wagers the Fed will cut rates in March, pushing swaps to levels consistent with only about 50% odds of a quarter-point reduction during the first quarter.

Treasury two-year yields topped 4.3%. The move also reflected a slide in UK bonds after data showed inflation picked up — making traders pare their bets on Bank of England easing. The dollar rose. The S&P 500 extended this year’s losses. Wall Street’s “fear gauge” — the VIX — hit the highest since November.

US retail sales rose at the strongest pace in three months in December, capping a solid holiday season that suggests consumer resilience heading into the new year. Separate data showed homebuilder sentiment climbed January by the most in nearly a year as lower mortgage rates boosted customer traffic, sales and the demand outlook.

To Andrew Hunter at Capital Economics, while a further slowdown possibly lies ahead, there is still little to suggest a sharper downturn is in store.

“A recession seems increasingly unlikely,” said David Russell at TradeStation. “Despite weathering an inflationary storm, consumers still have pent up demand and dollars to spend. A soft landing could be taking shape before our eyes.”

With consumer confidence gaining momentum, the economic landscape remains on solid ground — and the market reaction suggests hopes for a March rate cut becomes more elusive, according to Quincy Krosby at LPL Financial.

In fact, there’s a repeated refrain from the throngs of financiers in Davos this week: rein in your rate-cut expectations.

Everyone from JPMorgan Chase & Co.’s Daniel Pinto to Standard Chartered Plc’s Bill Winters to Cantor Fitzgerald’s Howard Lutnick have said they expect monetary policy to ease slower than anticipated by the market.

Still, traders continue to expect the Fed this year to embark on a reversal of the aggressive tightening campaign that lifted the cap on the federal funds rate to 5.5% in July 2023 from 0.25% at the start of 2022. But they look for the cuts to total about 140 basis points, down from a recent peak near 175 basis points.

Jason Draho at UBS Global Wealth Management says that it’s unlikely to be a smooth path for markets.

“Investors will be debating the type of soft landing, stage of the cycle, and the macro regime, and the wide dispersion of views now could quickly evolve based on new data,” Draho said. “That could lead to quick and dramatic market pivots to price in shifting consensus views.”

And as the earnings season continues, investors will need to consider their rate outlook alongside financial results, according to Jose Torres at Interactive Brokers.

“Robust pricing power and profitability are likely to lead to persistent inflationary pressures, which will incrementally delay rate cuts,” Torres said. “Weaker earnings trends, on the other hand, may lay the groundwork for monetary policy easing, but at the cost of deteriorating corporate fundamentals.”

CORPORATE HIGHLIGHTS:

Operators of Boeing Co.’s 737 Max 9 have completed inspections on an initial batch of 40 planes, a key step to eventually end the grounding of the aircraft ordered by US regulators in the wake of an accident earlier this month.
Apple Inc. has to stop selling its Series 9 and Ultra 2 smartwatches with a blood oxygen feature in the US, suffering another legal setback in its patent dispute with Masimo Corp.
Charles Schwab Corp. reported declines in profit, new assets and deposits as it navigated a tumultuous year of interest rate hikes that dented the firm’s balance sheet.
JetBlue Airways Corp. sank as investors assessed the fallout from its failed pursuit of Spirit Airlines Inc., dragging down carriers across the low-cost end of the market.
Bayer AG laid out plans for sweeping changes including significant job cuts in its managerial ranks, as new Chief Executive Officer Bill Anderson seeks to revive the crisis-rattled company.
Birkenstock Holding Plc’s first earnings report as a public company on Thursday is ripe for volatility as investors gauge whether the negative reaction to its 2023 initial public offering was overdone.
Samsung Electronics Co. is turning to artificial intelligence features to revamp its flagship Galaxy smartphones, betting that the technology can give it an advantage over Apple’s iPhone.
Verizon Communications Inc. is writing down the value of its business services division by $5.8 billion, a sign of the company’s declining enterprise operations.
Dish Network Corp.’s debt exchange ambitions are causing consternation among traders who bought a form of insurance that pays out if the struggling satellite television company defaults, according to people with knowledge of the matter.

KEY EVENTS THIS WEEK:

US housing starts, initial jobless claims, Thursday
Republican presidential primary debate in New Hampshire, Thursday
ECB President Christine Lagarde participates in Davos panel discussion, Thursday
ECB publishes account of December policy meeting, Thursday
Atlanta Fed President Raphael Bostic speaks, Thursday
Canada retail sales, Friday
Japan CPI, tertiary index, Friday
US existing home sales, University of Michigan consumer sentiment, Friday
ECB President Christine Lagarde and IMF Managing Director Kristalina Georgieva speak in Davos, Friday
San Francisco Fed President Mary Daly speaks, Friday

Some of the main moves in markets:

Stocks