Robust US economic data is confronting investors with an unexpected question: whether strong growth can keep driving stocks higher even if the Federal Reserve delivers less monetary policy easing than the market had hoped.
Expectations that the Fed would begin cutting rates sent stocks soaring at the end of 2023 and pushed the S&P 500 to a record high in January.
The index is up 4 per cent this year after surging 24 per cent in 2023.
That narrative has been jolted by evidence that the economy may be running too hot for the Fed to cut rates without risking an inflationary rebound.
Friday's blockbuster US employment number was the latest sign of stronger-than-expected growth, after Fed Chairman Jerome Powell days earlier deflated hopes the central bank would begin lowering rates in March.
“Looking back on the fourth quarter and the recent rally in stocks, a lot of it was driven from the thought of a Fed pivot, and the Fed pivot is evaporating in front of our eyes,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management.
Market expectations of a near-term rate cut dimmed after the jobs data, with futures tied to the Fed's main policy rate reflecting a 70 per cent chance of the central bank lowering borrowing costs at its May 1 meeting, from more than 90 per cent on Thursday, according to the CME FedWatch Tool.
The probability of a March cut stood at about 20 per cent, from just under 50 per cent a week ago.
With Friday's jobs report, “the six or seven rate cuts that markets had been pricing in seems very offside”, Seema Shah, chief global strategist at Principal Asset Management, said in a written commentary.
Friday's jobs report showed non-farm payrolls increased by 353,000 jobs last month – well above the 180,000 increase expected by economists polled by Reuters.
The economy also added 126,000 more jobs in November and December than previously reported.
Plenty of investors believe the strong growth is a positive for stocks, especially if accompanied by better-than-expected corporate earnings.
US Federal Reserve optimistic, keeping interest rates steady
The S&P 500 hit a high on Friday after the jobs data, helped by the soaring shares of Facebook parent Meta Platforms and Amazon, which rose 20 per cent and 8 per cent, respectively, following their corporate results.
For 2024, S&P 500 earnings are expected to jump nearly 10 per cent after a 3.6 per cent rise in 2023, according to LSEG data.
“I'll trade a stronger economy with less rate cuts than a weaker economy with more rate cuts,” said Keith Lerner, co-chief investment officer at Truist Advisory Services.
Analysts at Capital Economics forecast a “banner” year for US stocks, finishing 2024 more than 10 per cent above current index levels at 5,500.
Optimism over the business potential of artificial intelligence, which helped power stocks such as Nvidia last year, are likely to drive those gains, they said.
However, sustained above trend growth poses another issue – fears of an inflationary rebound.
“January job growth figures were strong, possibly too strong,” said Russell Price, chief economist at Ameriprise, in a Friday note.
“There were multiple signs of strong wage growth, which could filter through to resurgent … inflation pressures if maintained.”
A longer period of high interest rates also could increase stress for areas of the economy that are already hurting, such as commercial property.
Ramped-up growth, along with expectations of rates staying at current levels for longer, could drive Treasury yields up.
Higher yields can pressure equities because they compete with stocks for investors, while higher rates raise the cost of capital in the economy.
The benchmark 10-year Treasury yield, which moves inversely to bond prices, hit 4.05 per cent on Friday.
Investors are still pricing in around 125 basis points of Fed cuts this year, LSEG data shows. That is down from around 150 basis points priced in earlier this week, but still far more than the 75 basis points the Fed has projected.
