What is the market mood? Straddling between hike / No Hike / Rate Cuts | Point to note - Nothing Goes in one direction forever. Cycles always prevail eventually. |

As I write this article, I will quote Howard Marks again in the context of the cyclical extreme as I had quoted him earlier in one of my articles on Jan 15, 2024 which was the point of turn of the market pendulum.

"It is important to be aware of the mood swings of the market, the Pendulum as Howard Mark says. When the Pendulum is at the extreme , it is inevitable it will move back towards the mid point sooner or later. The movement towards an extreme itself that supplies the energy for the swing back.

Risk management is a challenge purely when one looks at measures of deviation move to the extreme. The timing of the move to the mid point, if captured wrongly, will prompt you to act in ways that will reduce the overall returns. Hence, it is of paramount importance, that we assess if we have reached cycle extremes.

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Over the week, US economic calendar had the PMI release wherein the Services and Mfg PMI came in below prior month readings and below consensus expectations at 50.90 and 49.90 respectively. Durable Goods new orders rose 2.6% mom but the underlying Core Durable Goods (i.e New orders excluding transportation) rose a paltry 0.20% mom.

The Initial jobless claims and continuing claims show a healthy labor market falling 5K over the prior week to 207K and 1.781mn from 1.796 mn prior week respectively.

Q1 GDP rose 1.60% but the disappointment in GDP numbers was on account of higher imports and a decrease in private inventory investment. Post the GDP release, the narrative has leaned towards still strong GDP growth in the U.S. and from the same report, data on Core PCE prices rose over Q1 3.70% annualized. Pending Home sales rose 3.4% mom and end of the week saw the release of US PCE prices which rose at 0.32% mom over both the core and headline prints though the print was largely discounted and not as high as many had feared.

The data supports the case for "higher for longer interest rates" and the markets have accordingly priced in 34 bps of rate cuts relative to a pricing of 68 bps at the start of the month. The mood of the market has significantly shifted and slowly and gradually, possibility of a hike has also started to creep into conversations. In my article posted on 03 Dec 2023 (link available), I laid out the peak and trough Fed Fund pricing. For Dec 2024 policy, the peak pricing was recorded at 4.86% and the current pricing is 4.99%. Terminal rate pricing was 5.58%. At that point in time, the base case assumption did not factor in the growth resilience which as large consensus agrees is on account of US fiscal dominance .

So from here, the worst case is one of price cuts being priced out and some 12 - 13 bps of rate hike gets built into price which equals 46 - 47 bps of swing factor from here (34 bps cuts wiped out plus 12 - 13 bps hike). Ideally, if we get a 25 bps swing factor, it will account for an extremely favorable risk reward.

Now, Couple of things to note here - data has been holding pretty well and while there is a case for higher for longer the bar to hike rates is sky high esp. considering this year to be an election year.

So if in the next week, we get any data surprises which push the possibility of rate cutes to lesser than 25 bps, I would start looking to fade the move and gradually splice into the position.

Key releases scheduled this week include the:

Treasury Quarterly Refunding Statement
FOMC Meeting followed by Press Conference
Non Farm Payrolls (exp 243K)

On that note, most things will prove to be cyclical and some of the great opportunities for gains and loss come when other people forget rule number one. ~ HM.

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