The market has grown weary of the interest rate hikes. Anytime we get some data that supports further hikes, the market tantrums and volatility ensues. Currently the assumption is that the Federal Reserve is done. I continue to think they have one more hike in them. We got numbers this week that support the narrative that the Fed will pause. The consumer price index (CPI) for April came in at 4.9%, slightly cooler than the 5.0% expected, and below last month’s 5.0% reading. This was the smallest annual increase since April 2021 and the 10th straight month of improvement since inflation peaked in June of last year at 9.1% We still have very little control over food and energy prices. Gasoline prices rose from the previous month, but food prices dropped. Annually, food inflation is still high at 7.1%, but it is down from 13.5% in August of last year. It is important to note from a historical perspective that the Fed has never ended its rate hikes before its policy rate exceeded the rate of inflation. We have now crossed that threshold. Headline inflation now at 4.9% and the fed funds rate at 5.0% – 5.25%. However, inflation is still way above target, and the stress in regional banks has not spread to other parts of the economy which is why I believe the Fed still has the runway to hike one more time.
It’s set in its ways
Markets like certainty, predictability and stability. It becomes very loud when it doesn’t get those things. Unfortunately, our current government provides none of those things. The uncertainty around the debt ceiling will lead to market volatility. The debt ceiling is a disruption but one we have dealt with in the past. Since 1960 Congress has raised the debt ceiling 78 times, which includes 20 times in just the last two decades. It will get resolved, but it may come down to the wire, just like 2011. A temporary suspension or kicking the can down the road type of solution is the most likely scenario.
It fell in with the wrong crowd
Sometimes Mom is wrong and their troublemaker child is the wrong crowd. U.S. small-cap stocks continued to lag its large-cap peers in the latest week, extending the asset class’s run of year-to-date underperformance. The Russell 2000 Index finished down about 1% for the week and is down about the same amount since the end of 2022. Historically, small cap stocks outperform coming out of a recession. We are coming out of a bear market not a recession, and the stocks that lead coming out of a bear market are usually the leaders of the previous bull market which is why large cap tech is doing well. Add in the fact that smaller bank stocks are facing a crisis and it is likely small cap stocks will continue to be the “wrong crowd”.