Labor strength, Red Sea disruptions, and unraveling the Fed’s rate outlook
Managing Partner, Chairman
Global Head of Corporates
Kennett Square, PA
2024 kicked off the year with a whipsaw in rates and a decline in equities, reversing some of the movement observed in the final days of 2023. The S&P 500 closed the first week of the year down, while the 10-year swung 20 basis points from its high to its low — closing at 4.04% — as the market digested fresh labor market data, observed headlines relating to the disruption in the Red Sea, and assessed the likelihood of rate cuts coming from the Federal Reserve in 2024.
Labor market update
The U.S. labor market continued to remain robust though showed signs of cooling in specific areas. Nonfarm payrolls came in at a +216,000 gain for December compared to forecasts of +175,000. The level was above last month’s reading of +173,000, though it is worth noting that November’s number was revised lower from +199,000. The unemployment rate came in at 3.70%, with no change since last month, but better than forecasts of 3.80%.
According to the ADP National Employment Report, private job gains rose for the fourth consecutive month as 164,000 jobs were added in December. This beat expectations of approximately 125,000. Leisure and hospitality led the way, while manufacturing was one of the only categories with negative growth. Meanwhile, the quits rate fell to 2.20%, which is the lowest level seen since September 2020. The quits rate is often viewed as a measure of labor market confidence. The data reflects a cooling in turnover and a potential cautious sentiment for the future, although, there were still 1.4 job openings for every unemployed person.
One additional data report worth noting is the ISM Services Index, which is comprised of four indicators: business activity, new orders, employment, and supplier deliveries. The index for December was released on Friday and came in at a level of 50.60, falling from November’s 52.70 level (a level under 50 indicates a contraction, while a level over 50 indicates expansion). The employment component of the Index declined to a level of 43.30 from 50.70, catching the market's attention and pointing towards cooling in the services labor market.
Logistical disruption in the Red Sea
Following multiple attacks on commercial vessels traveling across the Red Sea, ocean cargo rates climbed, upward pressure was put on oil prices, and some companies announced they will divert vessels from the Red Sea to alternative routes. Sending ships around the southern tip of Africa rather than through the Red Sea may add weeks to shipping times and significant increases to costs. The disruption raised concerns around supply-chain disruption and potential impacts to inflation.
Latest from the Federal Reserve
Last week, the FOMC meeting minutes were published from the December meeting. The main takeaway was that the Federal Reserve indicated interest rate cuts are likely for 2024, though there was no specific indication as to when the first might occur or the pace at which they may take place. As for the current market expectations, Fed funds futures implied that the market is currently pricing in the first 25-basis-point cut as soon as March (62.00% implied probability), with six, 25-basis-point cuts priced in through 2024 (at the end of December, this was as high as seven).
Richmond Federal Reserve President Thomas Barkin spoke last Wednesday, where he expressed confidence in the future of the U.S. economy and stated that the Fed has made real progress. He also painted in broad strokes when discussing what the next year would look like, including a scenario where another rate hike could be on the table. Outlining a variety of possible events, Barkin discussed the economy “running out of fuel,” the potential for “unexpected turbulence,” or even a “delayed landing” narrative in which inflation remains stubbornly elevated.
Rates rose nearly 20 basis points over the week through Friday morning, though we saw rates close five basis points lower than the peak during a volatile last session. The market seems to be slowly coming more in line with the Fed’s narrative, but there is still room for rates to rise if the forward curve will ever align closely with the Fed’s narrative. Recalling the December meeting where the FOMC published their dot plot, their submissions showed the voting members, on average, saw the target short-term rate at 4.625% by 2024 year-end (implying three, 25-basis-point cuts throughout the year). If there is anything certain for 2024, it is that volatility and uncertainty will continue. As a result, we are seeing a variety of companies assess their capital structure mix and execute interest rate swaps as a tool to achieve predictability, reduce interest expense immediately in the short term, and lock in the market-implied cuts that are currently priced into the forward curve which are more aggressive than the Fed’s current narrative.
Investors will have their eyes on fresh inflation data as CPI and PPI will be released on Thursday and Friday of this week respectively.
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