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Inside Markets — Rebalancing Pressure

Rebalancing Pressure

March 25, 2024

Month and quarter-end rebalancing could pressure stocks this week. The net effect could result in ~1.5% of underperformance from equities relative to bonds.

Friday’s core PCE print is the next macro catalyst for markets, but Powell’s nonchalant attitude toward the Jan/Feb inflation prints de-risks the event in our view. A de-risked February PCE report supports the idea of trend continuation at least until the March CPI print on April 10. Despite Powell’s dovish rhetoric, a hotter than expected March CPI report will likely delay, reduce or eliminate rate cut expectations into year-end. This would cause bond yields to reprice higher and pressure equity multiples. Last week’s flash PMIs were the first of the March reports and the inflation readthroughs suggest pricing pressures remain with input costs rising at the fastest pace in six months, while firms increased their selling prices to the largest extent since last April. The report also included the following: ‘Costs have increased on the back of further wage growth and rising fuel prices, pushing overall selling price inflation for goods and services up to its highest for nearly a year. The steep jump in prices from the recent low seen in January hints at unwelcome upward pressure on consumer prices in the coming months.’ The March CPI report will be followed two days later by the start of CQ1 earnings season, where expectations are fairly upbeat given what looks like above-trend GDP growth during the quarter.

The cyclically-sensitive RTY continues to coil beneath key technical resistance near 2100. The index is neither overbought nor oversold but looks like it wants to press higher. A sustained break above ~2100 would be an encouraging development for the broad market and opens the door to a potential catch-up trade in small-cap stocks. Cyclical cross markets like the Philadelphia Semiconductor Index (SOX) and Mexican peso (MXN) have been notably strong this year, while the price of copper (HG1) has also recently rallied. Unfortunately, copper is now trading ahead of its fundamental drivers, which we feel gives the metal elevated pullback risk.

Ten-year bond yields usually start to decline about six months prior to the first rate cut. That still lines up for a June rate cut, in our opinion. A muted easing cycle should still be good for about 125bp of pullback, suggesting a 10-year yield target of ~3.75% before the June Fed meeting. If we can get through the April CPI report without an upside shock, we see 10-year yields in the 3.90’s as a more realistic level. On QT, we expect the Fed will begin to slow the pace of Treasury runoff at the May meeting.

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