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Brian Pietrangelo:
Welcome to the Key Wealth Matters weekly podcast where we casually ramble on about important topics including the markets, the economy, human ingenuity, and almost anything under the sun, giving you the keys to open doors in the world of investing. Today is Friday, March 15th, 2024. I'm Brian Pietrangelo and welcome to the podcast. And we have a couple of events coming up in the next three to four days. The first one being this Sunday is St. Patrick's Day. So hopefully the luck of the Irish can bring us some good news in the stock and bond markets for the remainder of the year. In addition, on Tuesday on March 19th, it actually represents the first day of spring, which technically, scientifically is also known as the vernal Equinox, and that is the term given to the fact that there is the equal amount of daytime and nighttime on that particular day, which again marks the beginning of spring.
And now I'd like to introduce our panel of investing experts, here to share their insights on this week's market activity and more. George Mateyo, Chief Investment Officer, Steve Hoedt, Head of Equities, Rajeev Sharma, Head of Fixed Income, and Ester Lau Senior Fixed Income Research Analyst. As a reminder, a lot of great content is available on key.com/wealthinsights, including updates from our Wealth Institute on many different subjects and especially our Key Questions article series addressing a relevant topic for investors each week. In addition, if you have any questions or need more information, please reach out to your financial advisor.
Taking a look at this week's market and economic news, we've got three items to share with you, starting with retail sales. In terms of the Census Bureau's update, and we've got a little bit of a good news / bad news story, we will start with the good news and that is as of February 2024, retail sales were up 0.6% continuing to show some strength in consumer spending, but that comes off of a little bit of the bad news, which was January's number, was actually revised downward from -0.8% to -1.1%, which is providing a little bit of that lift for February. So a little bit of mixed message will continue to provide updates on an ongoing basis for you.
And secondly, on the other side of the equation from the consumer, we've got manufacturing in terms of industrial production that was reported by the Federal Reserve for the month of February was actually up 0.1% in its preliminary number, and that is good news as well, coming off of two negative consecutive months in December of January, of again, -0.3% production and -0.5 production. So 0.1% on the uptrend.
And thirdly, or finally, the big news for the week is around inflation. Earlier in the week we had consumer price index inflation, or CPI, came in hotter than expected in February of 2024. On a month-over-month basis, it was up 0.4%, which was higher than both January and December at 0.3 and 0.2%. In addition, the core excluding food and energy prices was actually up 0.4% as well month over month.
If you look at those numbers year over year, all items were up 3.2% in February, again, which was a little hotter than January, but the core excluding food and energy was up only 3.8% year over year, which is slightly lower than January's number at 3.9%.
We also had the producer price index of inflation that came in hotter as well, so all in all, the numbers again lead us towards the conversation of whether or not the Fed will take this into consideration for their meeting next week for inflation being higher than normal, which would mean potentially the Fed keeping rates higher for longer. We'll have that discussion with George and Rajeev and we'll look forward to that discussion here in a couple of minutes.
So George, let's turn to you for your reaction on the economic data and in the past podcasts we usually talk specifically from your voice, George, about the equal opportunity between risk going forward for the market uptrend and risk going forward for the market pulling back a little bit, relative to where we see that equal level of risk, just like the vernal equinox. So going forward, George, how do you think this data this week, especially on CPI, shapes our outlook for the economy and the markets?
George Mateyo:
Well, I do think, Brian, that there were some puts and takes from the data this week. I think overall we can see that jobless claims, we often talk about those as a good leading indicator for the labor market and they still seem pretty healthy. So the labor market still seems to be in good shape and of course that could change pretty quickly. And last week as we noted, there were probably some signs of softness, but maybe not too widespread to be concerned just yet, but I think we can check that off our list in terms of things to worry about this week. So the labor market still seems to be pretty healthy. You mentioned retail sales, they were a bit soft and probably softer than expected because January was a pretty soft month and there's a lot of distortions with weather and that maybe made the numbers look a little fluky, but I think overall the consumer is in okay shape.
I mean, maybe they're slowing down a little bit. We'll see maybe when the weather gets a little nicer, those things will reverse, but for now it seems like maybe there's some slowing down there as well. But inflation I think was the key story this week, as you mentioned. And frankly, I think we could also glean from that, that there are signs of inflation not accelerating, so it doesn't seem like it's in a really serious way, but it's also not receding and that's probably causing some concern a little bit too. And we've talked about the fact that the Fed has been penciling in three rate cuts this year. We've kind of suggested that the market was mis-priced, frankly, that the beginning of this year when they were thinking the market was thinking that they might be cutting seven times. So we've tried to walk back from that and I think we've been on the right side of that.
But I think it is fair to say that the Fed is kind of in a difficult position in the sense that when you start to see slowing conditions in consumer spending, in hiring and so forth, at the same time that inflation isn't cooperating, they've got to figure out maybe what to do. And I think that poses some challenges for them. Other parts of the world are seeing inflation come down to, although saw this morning that wages in actually Japan rose for the highest rate in over 30 years, which is quite staggering to see that. Of course they've had some issues with inflation there that probably... I don't want to get into that too much right now, but it does suggest that maybe other parts of the world are dealing with this too, that can create some distortions for the Fed they have to think about. Europe's in a different situation where inflation is really slowing quite dramatically and it seems like their central bank might actually be cutting rates sometime probably quicker than the Fed, which would be kind of unusual.
But back here in the United States, again, I think the Fed is in a difficult situation trying to figure maybe what to do with policy. We've been arguing more recently that maybe they don't do anything and maybe just sitting there and letting the market continue to evolve makes some sense and the market coalesce around that. So Rajeev, if you put this in a blender and think about what the Fed's thinking is right now with respect to inflation, how do you think they set the table next week when they get together more formally to talk about policy?
Rajeev Sharma:
Well, George, I think the CPI print beating expectations, it wasn't really good news for the market or the Fed. This was the second straight beat and showed that January was not a one-off anomaly. The big question is, does this print provide the Fed with an opportunity to shift tone next week on the FOMC meeting? It certainly makes things tricky for the Fed. They have their summary of economic projections that will be released next week. We'll get to see the Fed dot plots. Are they going to point to three rate cuts for 2024 or do they shift to two rate cuts for 2024? There are enough Fed members right now, they may find the inflation to be too sticky.
You made a really good point about, it's not increasing but it's also not receding. And I do feel like there are Fed members that will find this print to be sticky. They may use the data as a cover to move towards a rate cut in July rather than June. I mean, if you look at swap spreads right now, the market is still calling for three rate cuts this year. But if you look at the reaction on the yield curve to the CPI print, we have certainly seen yields move higher this week. Right now there's about a 60% probability of a rate cut in June. That was around 80% just a week ago. This week we saw the two-year Treasury yield, which is the most sensitive Fed policy, move 20 basis points higher to 4.72%. We also saw the 10-year Treasury yield move 30 basis points higher to 4.31%. And it just showed you how important every single piece of data is, especially when it's inflation data, not just for the Fed but also for the market.
This is pure volatility. I would add that it's not just the data that is keeping yields elevated. We also had Treasury auctions this week. They added more Treasury supply, namely 10 year and 30 year auctions. This continues to add pressure on yields, keeps them elevated. And I'll also note that the 10-year Treasury option was pretty weak and it's showing some jitters in the market.
What else can cause yields to move higher? We had continued corporate supply, new corporate issuance this week. Corporate treasurers are really using this current environment to push new bond deals to the market. Credit remains rock solid and the demand for corporate bonds is unwavering. So we saw investment grade default index right now the tightest level since 2021. So there's still a lot of demand for corporate bonds, but all these issues are coming to market. It's also keeping yields elevated. We have about three months, George, until the first realistic chance of a Fed cut. That gives the Fed and the market time to adjust and readjust their expectations. If inflation remains at 3% during this timeframe, we have to get used to a scenario where 5% Fed funds rate could be a reality rather than 4% Fed funds rate. So all eyes are really on next week, on the FOMC meeting.
George Mateyo:
And Steve, what are your thoughts on the equity market? I mean, the equity market has been kind of in a state of churn lately. We've seen some days, risk on, risk off. You've seen some of the big defensive names do well on certain days and then they kind of give back. So it seems like we're kind of looking for a direction right now, it seems like to me. What do you think?
Stephen Hoedt:
Yeah, I don't disagree with what you said, George. When you take a look, people have been a bit puzzled by why the market has been rallying a lot, especially with the inflation data coming in hotter than expected. And when you combine that with some activity data that you kind of referenced before, which have been a little bit softer... But to us that has a ring, and I hate to use the cliche, but it's almost like it's not too cold, not too hot, but just right. So it kind of plays into the Goldilocks narrative. So equities have been kind of churning here, close to all time highs. The Nasdaq 100 index actually been down four out of the last five days. Semiconductors have been down greater than the Nasdaq 100 has been. So we've seen some of the hot tech names come off the boil a little bit.
And quite honestly, that's not necessarily a bad thing for this market. Things may have gotten a little bit frothy there with the AI theme to start the year. I mean, you can look at some of the names that proxy that, you see them up over 80% year to date. It kind of just jumps out of the page at you.
We have started to see a little bit of a rotation into some of the more cyclical parts of the market, which is something that we've talked about for a while that we want to see because we'll feel a lot better about this market if participation broadens from just being concentrated in the technology sector. We've seen industrials improving lately, and I personally like to see that broaden out to some of the other cyclicals materials in energy and particular, and I know our special guest here is going to talk about it in a little bit, but financials also have been doing okay.
And I've talked on these calls before, financials don't need to be leadership in the market, but you can't have them going down on a consistent basis and having the market be healthy. And what we've seen here lately is the financial sector banks in particular have kind of been going sideways. So things are clearly, in our view, firming up there. I think that as we head into the next couple of weeks, we do have some catalysts. Nvidia has a large technology kind of confab that they're going to be having, and I think there's going to be a lot of eyes on what comes out of that. It's funny, but we've gotten to the point where that name is important enough to the market that, when they have technology roadmap meetings, that it becomes an actual market moving event. But we're looking at things like that in the next couple of weeks as well as a holiday shortened week two weeks from now.
So it seems to us that things right now are again in that Goldilocks scenario, and maybe we churn here a little bit before we eventually resolve ourselves higher, it's really hard to see this market having a difficult time unless we were to have some kind of dislocation in rates, meaning that we were to see the long end of the yield curve move back toward 5%. And right now we don't really see anything that's telling us that that's going to happen imminently.
Brian Pietrangelo:
Steve, thanks for your comments. Insightful as always. And you did tee up a nice segue with regard to the financial sector. And we've got our special guest here joining us on the podcast, Ester Lau, our Senior Fixed Income Research Analyst, who was actually going to take us back a year ago. Roughly, approximately the anniversary of what we saw in the banking sector crisis a year ago in March of 2023, to give us an update on her perspective in terms of what happened back then and where are we now. So from that perspective, welcome Esther to the podcast and it's glad to have you here.
Ester Lau:
Thanks, Brian. Thanks for having me on the podcast today. The past year or so has been one of the toughest periods for US banks in recent history, just given all the rapid rate hikes by the Federal Reserve and a new work from home trend born out of the pandemic. We saw a few noteworthy banks collapse in the first half of 2023, and as a result, investors' sentiment on the banking sector understandably had been negative throughout the year. And this negative sentiment was generally the case until towards the end of the year. Towards the end of last year, investors began to believe that the Fed may start cutting rates soon after seeing some positive economic data come out. And so when you couple that with more stable bank performance metrics at that point, that was when investors start to think that maybe the worst is now behind us and that the sector will be better from here on out.
And so the sector came into this year with relatively more positive sentiment, but unfortunately that didn't last too long. At the end of January of this year, we saw a regional bank surprise in the investment community when an unexpectedly reported a loss and said that it was going to cut their dividends by more than half. When news of this came out, overall, US bank equity fell about 4.5%, and within this broader bank sector, US regional bank equities dropped by about 10% while their credit spreads widened at least 10 basis points.
Now, clearly this market reaction was not very positive and was largely driven by renewed fears about whether or not we'll see another bank collapse and if the rest of the sector will see a repeat of the 2008 crisis. Now I don't believe that that's going to happen. What happened to that regional bank was basically due to growing pains. The bank had grown to have over a hundred billion dollars in assets, and what comes with becoming a hundred billion bank are more stringent regulatory requirements that the bank has to now ramp up on.
And so that's essentially what occurred there. It was something that was specific to that bank alone rather than to the entire banking sector. So I don't believe that this event alone changes the overall sector's health. And as Steve alluded to earlier, I believe the market is also seeing something similar now, where finances are now starting to firm up more.
But with that said, we're not completely out of the woods just yet. Certain risks such as office real estate, for example, has been and continues to be a headwind to banks given the new work from home trend, and we continue to monitor that risk every day, but even so, the sector is on a much better footing today than in eight, primarily because of the more stringent regulations that was born out of the 2008 crisis. And so with the continued resiliency of the US economy, upcoming regulatory requirements that will improve the health of the sector, a relatively more stable yield curve, and just generally still solid bank capital levels, I think that 2024 will shape up to be a better year than 2023 for the overall banking sector.
Brian Pietrangelo:
That's a tremendous update, and thanks so much for sharing it with our listeners today, because as listeners of the podcast, you get the VIP treatment with advanced notice of this conversation. Please take a look for next week when the article on the Key Questions series gets dropped from Ester on this specific topic. So again, thanks for bringing that up and also, in your terminology of the corporate real estate, we're also going to tee up, take a look at April 10th on your calendar because we're going to be having a national call where George and others on the team are going to host some guests and talk specifically corporate real estate. So again, stay tuned and you get all your information that you need right here.
Well, thanks for the conversation today, George, Steve Rajeev and Esther. We appreciate your insights and thanks to our listeners for joining us today. Be sure to subscribe to the Key Wealth Matters podcast through your favorite podcast app. As always, past performance is no guarantee of future results, and we know your financial situation is personal to you. So reach out to your relationship manager, portfolio strategist or financial advisor for more information, and we'll catch up with you next week to see how the world and the markets have changed and provide those keys to help you navigate your financial journey.
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