Locked Stocks and Smoking Oil Barrels 

European stocks rose early on Thursday despite a soft session in Asia and a decline on Wall Street after Federal Reserve meeting minutes pointed to the central bank taking a very cautious approach to rate cuts this year. The Nasdaq composite fell more than 1% to notch its fourth straight down day, whilst the S&P 500 lost 0.8% as investors sold the tech darlings of 2023. We talked about mean reversion in the market on Tuesday as Apple sold off and it continued into Wednesday’s session. The FTSE 100 trades a tad firmer this morning but is struggling to break out above 7,700 having shed 0.5% yesterday.  Oil prices extended gains after rallying 3% on Wednesday on supply concerns in Libya and further attacks in the Red Sea shutting shipping lanes. 

Fed Cautious on Rate Cuts 

Fed minutes indicated greater hawkishness than implied by the market reaction to the Dec meeting. This was no surprise. The dot plot only ever implied one additional rate cut in 2024 from previous iterations of the projections, and this was to be brought forward from 2025, implying monetary policy would not be any more restrictive in the long term. The market really latched onto a couple of remarks from Jay Powell in the presser – the minutes reveal a more cautious bunch of policymakers. They don’t want to say they’ve won and the mindset is naturally more cautious now – too loose on the way in and too tight on the way out.  

 The Fed minutes showed "participants viewed the policy rate as likely at or near its peak for this tightening cycle, though they noted that the actual policy path will depend on how the economy evolves" and they "reaffirmed that it would be appropriate for policy to remain at a restrictive stance for some time until inflation was clearly moving down sustainably".  

Overly Optimistic Expectation of Cuts Amid Inflation Concerns? 

Moreover, there has been a degree of complacency in the market about how the Fed views inflation – I don’t think the market gets that the Fed will last the course so long as the labour market holds up. This dawning realisation should put pressure on risk assets in the early phases of this year, particularly given the scale of the move in the market since Dec 13th. The question is how much more can inflation come down. The headline rate for November inched down to 3.1% on an annual basis from 3.2%. But core inflation rose – it was up 0.3% during November, while the year-on-year core rate remained flat at 4%. The last mile will be the hardest – the Fed could disappoint the market’s belief in cuts coming in the first half of the year should inflation be a bit more stubborn. Next Thursday’s CPI data will be important.  

Markets currently price in a cut by March but this seems way too optimistic, and it looks like June may be a better bet. Stocks are priced for perfection – soft landing and multiple rate cuts – but you cannot have both surely? I think instead the Fed stays higher for longer, mindful of pulling the cord too early and risk setting off inflation again. Investors will probably see this as being too restrictive and raising the risk of recession.  

And we have the inflation genie still. Six-month core consumer price inflation in the US may well pick up in the first quarter, which will stay the Fed’s hand as far as rate cuts are concerned. It would take a big slowdown in the economy or labour market to force a rate cut before June. Still the market thinks 150bps of cuts vs 75bps implied by the dots. Yesterday the JOLTS job openings dropped by 62,000 to 8.79 million. Weekly unemployment claims, fc 217k, and ADP payrolls, fc 120k, today should be watched ahead of tomorrow's NFP.  

European Inflation and Central Bank Policy 

Meanwhile it’s a not dissimilar story for Europe, at least as far as inflation is concerned. France’s annual inflation rate rose to 4.1% from 3.9% in December, in line with expectations as energy subsidies are phased out. Germany is set to be even starker, rising to 3.8% from 2.3% in November. Bavaria this morning at +3.4% vs +2.8% in Nov, Hesse +3.5% vs +2.9%, as a flavour ahead of the national data.  

We talked here before about how a pick-up in inflation at the start of the year would make it harder for the European Central Bank to cut as much as the market would like. The ECB will want to look at wages before acting – Schnabel last month noted that “We’re going to watch upcoming wage agreements very closely." Given the sharp pick-up in inflation at the start of 2024, we could see the ECB also delay until at least the summer before it starts cutting. 

Equities  

Next rallied to the top of the FTSE 100 after raising its profit outlook, whilst JD Sports slumped by a quarter after it joined Nike in warning on slower demand for sporting goods. Next posted yet further signs of an upswing in UK consumer spending in December that suggests Q4 GDP growth might show recovery from the slow start in October. Full price sales rose 5.6% in the nine weeks to the end of December...online was the star but behind the scenes is an incredibly dynamic shop-window store offering that works well with the online delivery channel. There have also been some really smart acquisitions in recent years – FatFact, Cath Kidston, JoJo Maman etc. Next has just got it right. Not too richly priced at 14x PE TTM.  

JD Sports was a whole other story and seems to be part of a global problem. Like-for-like sales +1.8% in the 22 weeks the end of Dec was sluggish and below expectations. Pre-tax profit estimate lowered to between £915m and £935m, a tenth below previous guidance of £1.04bn. Apparently way too much stock and a lot of aggressive discounting in the sector.