The start of 2024 brought about a sense of uncertainty following the robust performances witnessed across various market sectors in the last few months of 2023. In early January there was a perceived overreaction to the FOMC pivot and benign economic indicators, resulting in a retracement of both equity and bond prices. However, as the month unfolded, a favorable “goldilocks” scenario emerged, characterized by lower inflation and a resilient consumer outlook. This contributed to a mixed performance for both equities and bonds. Expectations of the Federal Reserve transitioning away from restrictive monetary policies sooner rather than later gained momentum and was clarified further by Chairman Powell during the January meeting. The Fed actions, along with a few other month-end news reports, prompted a decline in interest rates, allowing stocks to continue their upward trajectory reminiscent of the trends observed in 1999.
Equity markets were once again led by communication services and information technology sectors. However, not all sectors experienced gains, as consumer discretionary, materials, and real estate all saw declines exceeding 3%, with real estate the most significant underperformer at -4.74%. The onset of earnings season brought forth numerous positive reports, but not all the so-called “magnificent seven” companies beat street expectations. Additionally, certain industries, despite boasting impressive revenues, lowered their future expectations and announced further cost-cutting measures. Following a volatile month and some choppy trading days in late January, the S&P saw a 1.68% increase, the Dow Jones Industrial Average returned 1.31%, and the Nasdaq concluded with a 1.04% gain.
At the year began, bond markets were positioned for a “mean reversion”. The prevailing consensus anticipated six interest rate cuts throughout the year, with the easing cycle possibly starting as early as March. Despite many strategists advocating for increased bond allocations and highlighting the strong bond performance in the fourth quarter, prices declined, with the perception of the current yield curve being seen as having moved “too far, too fast.” As January unfolded, various factors, including actions from the US Treasury, the FOMC, and the banking industry, provided catalysts for a rebound in the treasury market, leading to a decrease in interest rates. Overall, rates experienced minimal changes over the month, with shorter bonds seeing a slight decrease in yield, while longer maturities increased a few basis points. Although the yield curve remains inverted, it is less pronounced than it was in the middle of 2023. Ultra-short maturities continue to offer the highest yields on the curve, with one-month T-bills yielding 5.4%. At the end of January, two-year Treasury notes yielded 4.25%, while ten-year notes had a yield of 3.88%.
The state of credit sectors remains a crucial subject of discussion. Spreads in both high yield and investment grade markets remain at extremely tight levels. Although high yield has closely followed the upward trend in equities, investors view absolute yields as indicative of a market “priced for perfection.” Investment grade spreads have averaged below 100 basis points compared to treasuries, much lower than historical norms. This factor contributed to the supply surge witnessed last month, with issuers spanning various sectors, resulting in the most substantial January corporate bond supply in the past decade, totaling over $188 billion in high-grade bond issuance, nearly double the January average. Despite the significant supply, the credit sector marginally outperformed treasuries, while shorter-dated corporate bonds performed better than longer-maturities.
Municipal bonds also experienced heightened supply activity during the month. Traditionally a slow period for municipal issuance, this January saw an infusion of nearly $32 billion in new bonds spurred by lower rates, marking the highest January figure since 2017. Although January typically sees positive trends as investor demand rises with the new year, the entrance of issuers into the market led to tax-exempt bonds experiencing a more substantial decline than treasuries. In fact, it represented one of the weakest January performances on record. Like other credit curves, shorter bonds outperformed their longer tenor counterparts.
Despite the abundance of news and economic highlights in January, the markets remained in a state of anticipation, awaiting guidance from the Federal Reserve’s end-of-month statement.
On January 31st, Chairman Powell delivered the Fed’s message. As widely anticipated, there were no changes in interest rates, and the committee reiterated its data-dependent stance regarding inflation and the economy. Powell acknowledged that the Fed was engaged in discussions about easing some of the restrictive monetary policy, signaling a departure from a prolonged period of stable rates. The FOMC also announced plans to further discuss the tapering of quantitative tightening in March. Surprisingly, Powell tempered expectations by dismissing the idea of immediate easing in March. He also took a “victory lap” for the decrease in inflation levels alongside a resilient economy – a few highlights below:
- “We’ve had inflation come down without a slow economy and without important increases in unemployment. There’s no reason why we should want to get in the way of that process if it is going to continue”.
- “Continued declines in inflation are really the main thing we are looking at. Of course, we want the labor market to remain strong, too. We don’t have a growth mandate. We have a maximum employment mandate and a price stability mandate.”
The bond markets rallied, as confirmation of a terminal rate was in hand. Equities initially experienced a decline, reflecting the realization of a potentially prolonged wait for lower rates and their impact on the economy.
A lot of the recent economic data aligned with the Fed’s message. The economy displayed strength right from the beginning of 2024. December jobs data exceeded expectations (216,000 versus the anticipated 175,000). Retail sales were robust during the holiday month, and both income and spending showed positive trends. Consumer sentiment surprisingly surged. The most substantial surprise came from the initial release of 4th-quarter GDP data, revealing a growth rate of 3.3%, significantly surpassing the expected 2.0%.
Inflation figures continued to move towards the Fed’s 2% goal. Core CPI met expectations at 0.3%, while Core PPI recorded a 0.0% monthly figure. Particularly importnat for the FOMC was the PCE data, with both headline and core figures hovering around 2%, markedly lower than the same period last year. The employment cost index also dipped below 1% for the 4th quarter.
In the final week of January, a couple of noteworthy events captured the attention of investors.
On January 29th, the U.S. Department of the Treasury made an announcement that it would “only” need to borrow $760 billion for the first quarter, a $55 billion reduction from previous estimates. This adjustment was attributed to higher net fiscal flows and an increased cash balance. The market reacted positively to this reduction in supply, providing some relief, as the recent treasury auctions were not well-received and saw “tails” to advertised yields. The larger auction sizes and the ballooning amount of interest owed by the U.S. government on its debt has been discussed as a potential long-term structural issue for the country.
On January 31st, nearly one year after the “mini-banking crisis” of 2023, New York Community Bank (NYCB) released its quarterly earnings report. The company reported a significant decline in earnings and slashed its dividend, leading to a 46% drop in its stock value. This development had broader implications as regional banks faced a downturn, resulting in a decline in financial indices. Expectations for a Federal Reserve rate cut increased on the news, and there was a brief flight to safety in treasuries. Of particular interest to investors were the details surrounding the bank’s deterioration, notably in office loans. Nonperforming commercial real estate, a risk that has been discussed for over a year, materialized.
Despite some favorable economic data and FOMC policy, 2024 may face some headwinds. Real estate, as previously mentioned, poses a concern. While earnings remain solid, there are anecdotal signs of cutbacks and layoffs. Geopolitical issues, particularly with rising shipping costs in the Middle East, persist. The upcoming Presidential election, taking shape, is anticipated to influence markets as early as this summer.