Today's data showing slower inflation growth could be welcomed by a market that's on the edge of its seat about the next interest rate move. The Personal Consumption Expenditures (PCE) price index, watched closely by the Fed, rose just 0.3% in February, versus analysts' expectations for a rise of 0.5% and down from 0.6% in January.
Stock index futures generally added to gains following the data, which helped ease one set of market worries. If the data had been screaming hot, it would have complicated things by working against growing impressions that the Federal Reserve might be able to pause rate hikes at some point this year.
The S&P 500® index (SPX) is on pace for its third-straight positive week and enters the final day of Q1 up more than 5% for the year, but from a longer-term perspective it remains within the 3,800 to 4,100 range that it's been in most of 2023. It's encouraging to see the recent rally in the face of Treasury yields that have mostly steadied following their recent retreat, and amid what appear to be growing expectations of at least one more rate hike.
The question following today's relatively benign inflation data is whether broad-based buying across sectors continues today after being a feature Wednesday and Thursday. Investors have shifted their focus from simply buying info tech and Treasuries and embraced some of the more cyclical parts of the market like industrials and materials, which could bode well if we hope to see a more extended rally.
Companies like Caterpillar (CAT), Boeing (BA), and Deere (DE) drew buying interest this week, and these are the types of firms that tend to do well in a growing economy. Still, technology shares have led the charge globally this quarter, with the Nasdaq-100® (NDX) surging 18.5%, the most since mid-2020.
Morning rush
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The 10-year Treasury note yield (TNX) fell 3 basis points to 3.52% after the PCE inflation data.
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The U.S. Dollar Index ($DXY) inched higher to 102.27.
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The Cboe Volatility Index® (VIX) futures slipped to 18.97.
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WTI Crude Oil (/CL) rose to $74.90 per barrel.
Just in
The price you pay: While headline PCE prices increased 0.3% in March, the core reading—which strips out food and energy—also rose 0.3%, versus 0.5% consensus expectations on Wall Street.
Headline and core PCE both fell from January's readings of 0.6% and 0.5%, respectively. Goods inflation, which has been weakening, rose just 0.2% in February; more importantly, services inflation—which had been surging—rose just 0.3%.
In other data earlier Friday, China's official March manufacturing PMI was slightly better than analysts had expected and still in expansionary mode, though down slightly from February. There was also positive news from Europe, where overall consumer price inflation dipped to 6.9% in March, the lowest in over a year. Declining energy prices helped, but inflation remains well above the European Central Bank's (ECB) 2% goal.
Feeling OK? Don't overlook the final March University of Michigan Consumer Sentiment figure expected at 10 a.m. ET today. It gains more importance following a better-than-expected Consumer Confidence report earlier this week from the Conference Board. Analysts expect Consumer Sentiment to remain relatively soft at 63.4, according to Briefing.com, unchanged from the initial March reading and down from 67.0 in February.
Extra credit: In a more positive development, credit spreads—a helpful indication of how willing banks are to lend and how eager- consumers and businesses are to borrow—narrowed again late this week, meaning less of a yield premium for investment grade and high yield bonds versus yields in the Treasury market. There's still some softness in certain names, but things appear to continue to stabilize from the recent banking events.
That said, credit is likely to tighten as small- and medium-sized banks try to shore up balance sheets and improve liquidity, says my colleague Kathy Jones, chief fixed income strategist at Schwab. If financial conditions remain on the tight side, the risk of recession rises.
Eye on the Fed
While bank fears have eased, there does seem to be a ceiling to how high this market can go if the Federal Reserve stays its course. Ideas that the Fed might pause interest rate increases in May drifted lower this week, in part because no one at the Fed has sounded anything but hawkish. Several Fed speakers are on tap today, so watch for any change in tone.
Following today's inflation data, the probability of a May rate increase fell to 47%, from 52% yesterday, according to the CME FedWatch Tool. It isn't a huge move and indicates market participants still see the early May rate decision as virtually a coin toss.
Stocks in spotlight
Though earnings season is still a couple of weeks away, a smattering of company reports this week inspired some optimism in a market that's grown used to expecting poor quarterly results.
When you look over data from companies that reported recently, including Walgreen's Boots Alliance (WBA), lululemon (LULU), Micron (MU), Carnival (CCL), McCormick (MCK), and Paychex (PAYX), there's a lot to like even if they didn't all sound terribly optimistic about the rest of the year. By and large, these firms either beat Wall Street's expectations or—in some cases—gave investors reasons to hope that the worst of their earnings struggles could be behind.
Another positive feature in this week's company reports was the top line, which is much harder for corporate finance whizzes to dress up. The bottom line is typically where you can "window dress" a quarter to make it look healthier. Revenue, on the other hand, speaks for itself: it's going to be either good or bad. And approximately 75% of S&P companies that reported this week beat analysts' revenue expectations. That remains an area to watch when earnings season begins.
While the flurry of earnings data we just received looked mostly robust, keep in mind that analysts generally expect another weak quarterly earnings season ahead for Q1, with a possible 6% overall decline in S&P 500 earnings per share (EPS). That would mark the second quarterly decline in a row, putting companies in what's commonly defined as an "earnings recession." A widespread drop in EPS, if that's what happens, could have a deep impact on the market, in part because we head into earnings season with major stock indexes priced above their historic averages versus projected earnings.
What to watch
The week ahead: Next week is shorter, with major exchanges closed on Good Friday. That could be awkward because it's not a federal holiday, meaning we'll get the March Nonfarm Payrolls report at 8:30 a.m. ET as normal but will be unable to trade on it until Monday (except in the futures market). This happens once in a blue moon and could lead to volatility or even more conservative trading ahead of the data release.
Factory gates: The March Institute for Supply Management (ISM) Manufacturing PMI comes right on the heels of Monday's open. Consensus among analysts is for a headline reading of 47.1, down slightly from 47.7 in February, according to Trading Economics. Any level below 50, if you'll recall, indicates contraction. February's reading was the lowest since May 2020 and under expectations. ISM Manufacturing has been in contraction four consecutive months.
Checking China: Even before Monday's sunrise, potentially market-moving data is on the way in the form of the China Caixin Manufacturing PMI for March, due Sunday night U.S. time. This important insight into the Chinese economy—which follows today's official government reading—ticked up to expansionary levels in February, the first increase in factory activity since last July. There've been mixed indications on China's reopening, and while this report won't answer everyone's questions, it's another important look under the hood.
Get Ready: Remember to check out Schwab's Weekly Market Outlook on Monday for Chief Global Investment Strategist Jeffrey Kleintop’s 90-second take on the markets for the week ahead.
Thinking cap
Ideas to mull as you trade or invest
Look twice: Investors flocked to shares of Apple (AAPL), Microsoft (MSFT), and Meta (META) over the last two weeks, perhaps expecting those huge companies to be somewhat shielded from banking industry instability. To date, they continue to hold up well. However, as my Schwab colleague Senior Investment Strategist Kevin Gordon recently notes, investors shouldn't view tech as a monolith. Even in a sector like tech, there's a decisive split in performance between companies with strong profit margins (the best-performing factor) and high debt (the worst-performing factor). If you're thinking of putting money into large-cap tech, you might want to carefully examine company balance sheets.
No guarantees: The same "not a monolith" lesson applies to other sectors, too. Both large and regional banks belong to the S&P Financial Select Sector Index (IXM), which has surged in a relief rally since the mid-March banking turmoil. But other companies besides banks make their homes here as well. That includes credit card firms like Visa (V) and MasterCard (MAC), and insurers. Keep in mind that some large insurance firms may be exposed to any heightened risk alarms around regional banks. For instance, shareholders suing executives of Silicon Valley Bank's parent company, SVB Financial Group (SIVB), also sued the company's insurer. Insurance company shares dropped when the banking news hit but recovered in the following weeks. Just remember that the market has many cross currents. When regional banks catch a cold, for example, insurance companies and real estate firms may start to sneeze.
Rulebook: Speaking of banks, more regulation could be coming their way as Congress and the Fed examine the causes for two U.S. bank failures this month. That's the takeaway from this week's congressional hearings on banking oversight, which featured testimony from Fed Vice Chair for Supervision Michael Barr. Proposals include enhancing the Fed's "stress tests" on bank failure to help identify how contagion could play out, as well as updated liquidity rules and changes to the Federal Deposit Insurance (FDIC). Banks' securities portfolios could also come under more scrutiny. For more in-depth analysis of the hearings and how they might affect banks, check this recent Schwab article.
Calendar
April 3: February Construction Spending and March ISM Manufacturing Index and expected earnings from Yum Brands (YUM).
April 4: February Factory Orders and February Job Openings and Labor Turnover Survey (JOLTS).
April 5: February Trade Balance and March ISM Non-Manufacturing Index. Expected earnings from Conagra (CAG).
April 6: No major data or earnings expected.
April 7: March Nonfarm Payrolls, March Wages, March Unemployment; major exchanges closed for Good Friday.
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