Recession and not inflation is the real equity killer Recession and not inflation is the real equity killer Recession and not inflation is the real equity killer

Recession and not inflation is the real equity killer

Equities 5 minutes to read
PG
Peter Garnry

Head of Equity Strategy

Summary:  Yesterday's US inflation report was a surprise, pushing equity markets, especially Nasdaq, lower. This hotter-than-expected inflation pushed rate cut expectations further down the calendar. A March rate cut is off the table, with first cut either in May or June, and by December we might see four cuts. This is a drastic change from the seven cuts envisioned earlier this year. So what happened? Sticky core services inflation, underpinned by wage dynamics, is refusing to budge, and global manufacturing is showing signs of life. If the goods economy kicks in on top of this already stubborn inflation, things could get interesting. Should equity investors be worried? As long as inflation stays below 4%, recession matters more. If the economy stays afloat, sentiment should remain positive. However, recent sky-high valuations could become a problem if companies cannot deliver on earnings expectations.


Inflation dynamics are delaying the market’s rate cut hopes

Yesterday’s surprise upside in the US January inflation report showing CPI YoY of 3.1% vs est. 2.9% and core CPI YoY of 3.9% vs est. 3.7% pushed equities lower with Nasdaq 100 futures leading the declines down 1.6%. However, the leading technology index futures are already up 0.6% today reflecting that this inflation surprise is going to derail the equity rally for now. Before go deeper into what yesterday’s inflation report means for equities it worth observing the market change in pricing Fed rate cuts.

The table below shows that the current Fed effective rate of 5.33% with the 3-month SOFR Mar-24 futures closing at an estimated Fed funds rate of 5.28 yesterday reflecting that a March rate cut is completely priced out. The table also shows the estimated Fed fund rates at different date points in the future from those SOFR futures from one week ago and the difference. As we can see that compared to just one week ago, the market has removed an entire rate cut (25 bps.) by the July FOMC meeting. The current estimated Fed funds rate at the July meeting is now 39 bps. below the current effective rate suggesting the market is leaning towards two rate cuts by the July FOMC meeting but that it is close to 50/50. The table also show that the market is pricing four rate cuts (Dec-24 contract is estimating Fed funds rate 91 bps. below current effective rate) by the December FOMC meeting which is drastic change from early this year where is market was at seven rate cuts. So what has changed?

As we wrote in our What are the Fed’s possible considerations on rate cuts? Equity note back on 1 February there were several factors that were pointing towards that the Fed would hold back. Some of those were sticky core services inflation, loose financial conditions, trend growth in the US economy, and tighter labour market is the recent monthly observations. Yesterday’s inflation report showed exactly what we have been talking about that the wage dynamics are creating sticky core services inflation which yesterday gained 0.66% MoM and annualizing the 6-month average MoM figures hit 5.6% annualized. The upside case now on inflation is this. Base effects from lower energy prices are diminishing now and the global manufacturing sector is showing green shoots with PMI figures showing highest activity levels since August 2022. Imagine the goods economy kicks into gear again on top of the current sticky services inflation?

Should equity investors be worried about these inflation dynamics and that the path to the Fed’s estimated terminal Fed Funds Rate is now presumably going to be longer? As long as headline inflation remains below 4% we are not worried for equity returns from the inflation angle. A recession or not means much more for equity returns, so as long as we are not seeing clear signs that a recession is incoming we believe equity sentiment will remain positive. But as we have also discussed in several recent equity notes the high equity valuation levels are quite high and thus pose a risk should companies suddenly not be able to deliver on those high expectations.

Nasdaq 100 futures | Source: Saxo
Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-hk/about-us/awards.

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.