US equities were weaker Friday, S&P 500 down 0.4% for the day and over the week. United States 10-Year yields are down 5bps to 3.81%, up 8bps over the week.
It is a short holiday week in the US, as markets are closed on Monday for President's Day. Nonetheless, there are still a few critical macro releases that will be in focus, including the scheduled release of the minutes from the February FOMC meeting, the U-Michigan Consumer Sentiment survey for February, and the January PCE reading.
The main focus of this week's holiday-shortened economic calendar will likely be Friday's personal income (+0.6% forecast vs. +0.2% previously) and consumption (+1.3% vs. -0.2%) release for January, which will include the latest reading on the core PCE deflator (+0.5% vs. +0.3%)
Given that the sum of last week's growth and inflation data was the exact opposite of the progress the Fed is looking for and singing the same "higher for longer" song page, I suspect markets will likely trade in a more defensive posture given that recent data development has resulted in significant revisions higher on the course of Fed policy.
This week's releases – particularly Friday's core PCE inflation data – will set the stage for Fed officials' forecast updates at the March 22 meeting. We doubt the revisions to the SEP will be in a dovish direction.
While the market expects the Fed to continue in 25bp increments through June and that the bar for returning to a 50bp pace is high, it is not insurmountable if growth and inflation data continue to rise above seasonal factors and post-pandemic distortions. And if the narrative shifts from hard to soft to no landing, the implications are that the Fed is not done with its tightening cycle beyond June.
While the inflation rebalancing process is well underway, the bar has been raised as markets do not expect the FOMC to cut the funds rate until a growth risk emerges; the Fed is now unlikely to cut rates even if inflation were to decline -- at least not if inflation were to decline alone.
The correlations between rates, DXY, and equities have all broken apart. The last few weeks have been a good reminder that these relationships are unstable over short time windows. Ultimately there are several bearish valuation arguments to be made. One can point to negative earnings revisions or a diminished ERP, but until something dislodges the price trend, an under-risked market will continue to draw in people chasing performance.
EM is weak again, with the ChiNEXT down nearly 2% on the week, but unclear in terms of catalyst. Perhaps this is simply positioning with the trading community overweight China/em and still underweight US/Europe.