April 25, 2024

Will A Resilient Economy Keep Inflation Hot?

Where do the markets and economy stand as we head into March? And what’s the inflation story? Let’s look back on what happened in February and then assess what it could mean for the road ahead.

Market Performance a Reflection of Economy

February was a good month for stocks. Most markets were up in the low- to mid-single digits, driven by positive economic and earnings news. The riskiest indices, the Nasdaq and emerging markets, performed especially well as investors stayed risk-on. It was a different story for fixed income, though, which generally declined as interest rates rose significantly during the month on fading hopes of Fed rate cuts. Both results, in their different ways, reflected the broader economy. But where growth continues, so too does inflation.

A Battle of Rates

Last month’s mixed markets were a battle between rates. Rates rose sharply, pulled back at month-end, and then closed significantly higher. Continued economic growth and the conviction that rate cuts from the Fed weren’t coming at any time soon drove the increase, pushing fixed income markets down. And it wasn’t just the Fed, as the economic news suggested inflation may not keep dropping.

Fourth-quarter economic growth for 2023 came in stronger than expected, and projections show that this will be the case for this quarter as well. Job growth was not only solid last month but accelerated, and wage growth and spending increased. Last month’s data revealed a resilient economy that will likely keep inflation reasonably hot—and keep rates higher for longer.

A Reasonable Prospect of Growth

Although higher rates usually mean lower stock prices, that outcome was overruled by expected strong economic growth, which could continue to support earnings growth. Last quarter’s corporate earnings came in well above expectations, which is the case for this quarter (so far) as well. While interest rates and valuations will be a challenge, the strong economy and earnings growth will potentially more than offset that. This means that we still have a reasonable prospect of growth.

Beware the Risks

While overall conditions are positive, risks remain. There is the Fed and interest rates. But we also need to consider the ongoing war in the Middle East, which is showing signs of expansion and affecting trade routes and supply lines. This could hurt inflation and growth. Further, domestic politics remain a concern, especially as the election gets closer. But with the fundamentals reasonably healthy and the macro picture stabilizing, many economic fears that pulled markets back last year may be subsiding.

As we move into 2024, the key issues remain how fast the economy grows and what that growth could mean for inflation. Indeed, market expectations on rates have changed rapidly. Right now, those expectations have aligned with reality, so the effects of the Fed are likely to be less negative going forward. That said, all of this is data-dependent, and we will need to keep an eye out for changes.

Volatility Ahead?

The bottom line is that conditions remain solid, but volatility is quite possible. There was some turbulence in February, and inflation remains a concern. While the trends are positive, risks could be on the rise over the next couple of months. Still, given the strong economic fundamentals, these risks are something to watch for—but not worry too much about.

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