by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Note to readers: the Daily Comment will not be published tomorrow due to the Good Friday holiday.

Good morning! While equities are showing a muted reaction to the revised GDP figures, we are celebrating the start of the MLB season. Today’s Comment dives into the rationale behind why investors shouldn’t overlook large-cap stocks. Additionally, we explore how central bank caution has supported the dollar, while shedding light on the factors contributing to the remarkable ascent of the Mexican peso, which has emerged as one of the top-performing currencies globally. As usual, the report includes a summary of domestic and international data releases.

Not Like the Rest: Hopes for Fed rate cuts and the froth in AI stocks fueled risk-on sentiment in Q1; however, this may not carry over into next quarter.

• Fueled by AI optimism and dovish monetary policy expectations, the S&P 500 surged 10% in Q1, its fastest year-to-date rise since 2019. Policymakers’ promises of rate cuts and tech companies’ defiance of expectations fueled this growth. However, recent headwinds threaten to stall this momentum. Fed officials, like Governor Christopher Waller, have grown cautious, downplaying the possibility of imminent cuts due to strong economic data. Additionally, concerns mount that tech valuations are stretched, potentially jeopardizing their outperformance streak. These mounting doubts raise the specter of whether these trends will be able to hold going into the next quarter.
• The market may experience volatility in the next quarter due to a confluence of factors. The Federal Reserve’s monetary policy decisions will be heavily influenced by upcoming employment data. Another strong payroll report, if it exceeds expectations like the recent ones, could lead policymakers to reevaluate their plan for interest rate cuts, potentially reducing the anticipated number to just two for the year. Additionally, investor sentiment is shifting as they look beyond the Magnificent Seven (M7) stocks, whose valuations are reaching expensive territory, and seek safer alternatives.

• The narrow leadership in the market’s 2024 rise suggests a Q2 pullback in momentum is more probable than a correction, absent a significant macroeconomic shock. That said, investors may be able to find value in large-cap companies outside the M7. Excluding those large-cap companies, the index has a P/E ratio of just under 19, which is right in line with historical averages. Given their size, those large-cap firms are relatively well-positioned to absorb changes in Fed policy compared to their mid- and small-cap counterparts and would likely benefit if the Fed follows through on its easing plans.

The Dollar Is Back! The greenback has roared to its strongest quarter in two years, as a shift in market expectations for central bank policy bolstered the dollar’s value.

• The US dollar has surged 2.7% in Q1, according to the Bloomberg Dollar Spot Index, fueled by a shift in central bank policy expectations. Markets initially anticipated interest rates converging globally, but recent pronouncements suggest a slower pace of easing. Echoing the Fed’s cautious stance, central bankers worldwide signaled a more measured approach. Bank of England Monetary Policy Committee member Jonathan Haskel indicated that the UK is a long way off from cutting rates, while ECB President Lagarde remained noncommittal on future policy easing after the ECB’s expected June cut. Meanwhile, the Bank of Japan distanced itself from any tightening bias.
• Central banks’ shift away from aggressive rate cuts has resonated with the market. Investors have adjusted their forecasts upward, anticipating a slower pace of rate reductions and a higher interest rate environment over the next three years. This hawkish tilt is particularly pronounced in 2025 projections, with US rates revised up by 70 bps and the UK seeing a 55-bps increase. These revisions suggest the market isn’t convinced that central banks in Europe and the UK will take drastic measures to cut rates independent of the Federal Reserve’s actions, despite economic weakness in those countries.

• The Fed’s aggressive rate cuts, which have historically started from higher points, often result in a lower terminal rate compared to other central banks. Even if the Fed cuts this year, whether before July or after the election, the dollar’s weakness would likely be temporary. However, the current combination of a strong dollar and high interest rates creates tighter global financial conditions than investors may have anticipated for 2024. This could potentially dampen global growth and make US equities more attractive relative to foreign markets.

The Super Peso: The Mexican peso (MXN) has defied expectations in 2023 by strengthening despite rate cuts and potential US tensions.

• The MXN has emerged as the world’s strongest currency against the dollar this year. Two key factors fueled this stellar performance. First, despite lowering its policy rate this year, Mexico boasts one of the highest interest rates globally, making it attractive for carry-trade investors seeking to profit from interest rate differentials. These investors buy foreign currency (like the dollar) and then invest those funds into a higher-yielding currency (like the peso). Secondly, President Andrés Manuel López Obrador’s (AMLO) plan to reduce government spending has helped curb national debt, bolstering investor confidence in the Mexican economy and its currency.
• Mexico’s strong peso hasn’t shielded its stock market from volatility in 2024. The MSCI Mexico soared nearly 30% in the final two months of 2023, but this year’s performance has been choppy. This uncertainty likely stems from outgoing AMLO’s late-term spending spree, which is expected to push the estimate of public debt as a percentage of GDP from 4.9% to 5.0%. Additionally, his presumed successor, Claudia Sheinbaum, has pledged to cap oil production at 1.8 million barrels per day, a slight decrease that suggests a potential move away from fossil fuels.

• Mexico’s upcoming election looms large over its financial markets. The country’s proximity to the US makes it a magnet for companies seeking North American market access. While AMLO has navigated relations with both US presidential contenders, uncertainty swirls around Claudia Sheinbaum and her ability to maintain these ties. Further complicating matters, tensions with the US are rising as Chinese firms attempt to manufacture electric vehicles in Mexico for the US market, attracting criticism from American lawmakers. Immigration, another perennial issue, adds another layer of complexity. If Sheinbaum is able to successfully avoid US hostilities, Mexican companies could present potential opportunities for investors looking for foreign exposure.

Other News: China’s most senior military leader has urged Asia to take responsibility for managing its own security, indicating that despite the thaw in tensions between the world’s two largest economies, significant geopolitical differences persist. The Russian propaganda machine remains active and potent, raising concerns that Moscow may attempt to influence the upcoming US election.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equity markets are off to a strong start today. In sports news, the NFL has announced a rule change to its kickoff format, making it similar to the format used by its competitor, the XFL. Today’s Comment dives into the nuanced reasons behind the Bank of Japan’s cautious approach toward significant shifts in monetary policy, explores consumer apprehensions surrounding the upcoming election, and examines the burgeoning AI frenzy making its way across Asia. As usual, we include a round of international and domestic news.

Yen Worries Continue:  The Japanese yen (JPY) weakens as the Bank of Japan indicates it will refrain from additional interest rate hikes, despite inflation exceeding its 2% target.

• The Bank of Japan threatened currency intervention to halt speculation, driving down the JPY. Earlier today, the currency plunged to a 34-year low of 151.97 per dollar, alarming policymakers. This sharp depreciation follows the central bank’s recent decision to end negative interest rates and to signal a pause in further tightening. However, Governor Kazuo Ueda’s dovish stance — suggesting the BOJ won’t raise rates aggressively until inflation expectations reach 2% — has spooked investors. Consequently, they’re dumping yen holdings in anticipation of other central banks, like the Federal Reserve and the European Central Bank, maintaining higher rates for a longer period than the market anticipated at the start of the year.
• Recent inflation data strengthens the Bank of Japan’s case for maintaining its dovish stance. Headline inflation rose 2.8% year-over-year, but this increase hasn’t translated to core inflation. The core index has remained flat since October 2023, suggesting underlying inflationary pressures are subdued. Furthermore, core inflation shows signs of further moderation, rising at an annualized pace of only 2.1% over the past five months, significantly lower than the 3.3% annual change observed in February. The setback in inflation has likely led policymakers to question whether the country has truly turned a corner in its fight against deflation.

• In a shift from past policy, central banks, including the Bank of Japan, are prioritizing a cautious approach to monetary policy. Their primary concern is to avoid triggering unintended economic downturns that would necessitate future policy reversals. This cautious stance extends even to central banks who have traditionally been seen as more hawkish, as evidenced by similar concerns about interest rate adjustments voiced by members of the European Central Bank and the Federal Reserve. This cautious approach by central banks is likely to keep the interest rate differential between the US and its peers stable or even widen it, potentially strengthening the dollar.

Election Concerns: Anxiety is rising among American households about the country’s direction, fueled in part by the potential for a rematch between President Biden and his predecessor, Donald Trump.

• Recent surveys paint a complex picture of consumer sentiment. While headline figures from the Conference Board and the University of Michigan suggest stability, a closer look reveals a growing unease about the future. This is evidenced by a decline in consumer expectations in the Conference Board’s March survey, with the six-month outlook dropping to its lowest point in six months (73.8, down from 76.3). The University of Michigan Sentiment Index echoes this trend, dipping slightly from 75.2 to 74.6. Notably, this weakening confidence emerges despite positive signs in the labor market and significant progress on inflation reduction from its highs in 2022.
• The forthcoming election appears to be a significant factor in the growing disparity between consumer sentiment and favorable economic indicators. According to the latest findings from the University of Michigan, the survey shows a downturn in sentiment among independent voters, while partisan optimism is on the rise among the two major parties. The Conference Board’s observations underscore a rising trend of write-in responses concerning the political climate. This coincides with a noticeable generational divergence among respondents. Individuals under 55 exhibit a considerable decline in enthusiasm, while those aged 55 and above demonstrate greater optimism.

• While the election may influence consumer sentiment, it likely won’t significantly impact short-term spending. This disconnect suggests voters perceive that neither candidate is offering solutions to improve daily living standards. A deeper reason could be the growing acceptance of a new economic reality: Low borrowing costs are likely gone. Tighter monetary policy and ballooning deficits are expected to keep long-term interest rates above 4% for the foreseeable future. This shift may force consumers who missed the window of easy credit to increase savings to maintain their desired financial stability. In the long run, this could stifle economic growth as households tighten their belts and reduce spending in order to adapt to the shifting economic landscape.

Emerging Tech: With tech stock valuations reaching lofty heights, investors are increasingly turning their attention to Asian countries to capitalize on the burgeoning growth in artificial intelligence (AI).

• US tech giants Meta, Nvidia, Microsoft, and Amazon have been driving the S&P 500’s returns this year, accounting for 55% of its gains so far. This surge is likely due to the increasing popularity of AI and the corresponding demand for semiconductors, which are crucial components in AI hardware. While some of the excitement may carry over from last year, Nvidia’s strong sales figures in Q4 have bolstered investor confidence that these companies can continue to deliver above-average returns in the future. That said, their high valuations have led investors to begin seeking cheaper alternatives.
• Fueled by the Asian tech boom, India, South Korea, and Taiwan have emerged as attractive destinations for investors seeking to diversify their tech holdings beyond the US. ETF flow data from Bloomberg shows that India is leading the way with $197 million in inflows year-to-date, followed by South Korea at $181 million, and Taiwan at $112 million. These countries are all well-positioned to benefit from the growth of key technologies like AI and semiconductors and are attracting investors seeking exposure to these trends. The rising inflow also reflects a growing investor preference for geographically balanced portfolios, with a focus on countries with strong economic ties to the US or those maintaining neutrality.

• Risk appetite is currently high, likely fueled by market expectations that central banks will begin easing monetary policy within the next six months. While US mega-cap tech stocks have been in the spotlight for years, their dominance seems to be fading. This is evident in the recent broad-based gains across the S&P 500. Investors seeking to capitalize on the AI boom might find opportunities abroad. Foreign AI firms have experienced impressive growth over the past year and currently trade at lower valuations compared to the well-established “Magnificent Seven” US tech giants.

Other News: Protests have broken out in Hungary after Prime Minister Viktor Orbán was implicated in a graft probe. The Bank of England has warned that a boom in private equity may negatively impact the country, elevating the potential for financial mishap. The Congressional Budget Office Director, Phillip Swagel, has warned of a “Liz Truss-style market shock” if the US government does not get its fiscal house in order.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Despite strong economic signs like positive durable goods orders, equity futures are paring back earlier gains. On a brighter note, the University of Iowa continues to dominate the Women’s NCAA tournament! Today’s Comment dives into why rising analyst forecasts for the S&P 500 shouldn’t lull investors into complacency. We’ll also explore how rising housing costs might impact the Fed’s policy decisions and analyze the likelihood of a slow US-China decoupling. Plus, we include our usual wrap-up of domestic and international data.

Equity Bulls on Tap: With the first quarter of 2024 nearing its close, several banks have already begun revising their year-end forecasts upwards.

• Oppenheimer Asset Management isn’t alone in its bullish outlook on the S&P 500. After a stellar first quarter, it has raised its year-end target from 5,200 to 5,500. This optimism is echoed by HSBC, UBS, and Bank of America, all revising their projections upwards to around 5,400 for the index by year’s end. Fueling this sentiment are the market’s strong gains and surprisingly positive corporate earnings reported in the final quarter of 2023. With the S&P 500 already up 10% year-to-date, further growth is anticipated if the Fed manages a soft landing.
• A cloud of uncertainty looms over the recent stock market optimism. Positive earnings surprises stemmed from analysts significantly lowering their Q4 2023 earnings per share (EPS) estimates ahead of reporting season, reflecting concerns about a potential economic slowdown later this year. Furthermore, liquidity in the financial system is expected to tighten in the coming months due to tax payments, ongoing quantitative tightening, reduced use of the overnight reverse repo facility, and interest rates remaining higher than market expectations. These conditions will likely prevent much of the cash being held in money market funds from returning to financial markets.

• The strength of the US economy bolsters optimism for equities, but hidden risks obscure the outlook. This is evident in the looming debt maturity wall. While leveraged loans offered companies a temporary lifeline, they’ve come at the cost of eroded profitability, potentially creating future solvency issues. There aren’t any glaring signs of an immediate crisis, but the lack of transparency in the private credit market remains a significant concern. Given these uncertainties, investors should exercise caution before taking on excessive risk, especially with policy rates hovering above 5%.

Fed Leaning Hawkish? Rising shelter costs are dampening the Federal Reserve’s optimism for three rate cuts this year, and the high home prices continue to fuel domestic inflation.

• Federal Reserve officials presented a divided front on future rate cuts this week. Voting member Raphael Bostic, President of the Atlanta Fed, pointed to stronger economic data and scaled back his forecast from two cuts to one. While Bostic expressed caution, Fed Governor Lisa Cook emphasized the potential hurdles on the path to price stability. In contrast, Chicago Fed President Austan Goolsbee held firm to his projection of three cuts, as outlined in the Fed’s latest Summary of Economic Projections (SEP). These divergent views highlight the complex interplay between robust employment data and higher-than-expected inflation on policymakers’ outlooks.
• Shelter costs remain a major hurdle for the Fed, delaying their shift on interest rates. While overall inflation shows signs of easing, housing prices act as a glaring outlier, driving a wedge in price trends. Excluding shelter, core CPI has held steady between 1.9% and 2.2% for the past seven months. This persistent rise in housing costs is often attributed to limited inventory and a slowdown in new construction. However, confusion clouds how this data is collected, with Fed Chair Jerome Powell himself acknowledging uncertainty about when the slowdown in housing prices will be reflected in inflation figures.

• Federal Reserve officials are signaling a cautious shift, with some openness to considering two rate cuts this year depending on economic data. While we expect the January and February inflation spikes to moderate, our confidence in the Fed achieving its target of 2% core PCE inflation by year-end has decreased. Stubbornly high shelter costs, a significant factor in inflation metrics, contribute to this hesitation. If inflation persists alongside a strong labor market, the Fed may postpone rate cuts until after the election.

Carrot and Stick Diplomacy: Despite China’s push for self-sufficiency in technology, it still seeks cooperation with US business leaders to temper U.S. hostility.

• On Wednesday, a select group of US corporate executives received an esteemed invitation to meet with Chinese President Xi Jinping. Following their participation in the high-profile China Development Forum, which wrapped up on Monday, these key players will convene for an exclusive gathering, aimed at providing insights into the nation’s burgeoning growth trajectory. The invitation arrives as US-China tensions escalate, fueled by policies targeting economic decoupling. With American businesses pulling back on investments in China, and Beijing planning to replace US technology, this high-level dialogue holds the key to shaping the future relationship between these economic giants.
• Despite recent tensions, a meeting between US CEOs and President Xi highlights the mutual dependence of the US and China. China’s manufacturing overcapacity strains its ability to sustain growth without access to US markets. This is particularly true for the electric vehicle industry, where China faces pushback from Western countries due to its surplus. However, US firms also rely on China’s vast consumer base for their own continued growth. Just look at Apple, whose sales of their flagship iPhone have dropped in China, prompting them to explore a partnership with Baidu to regain a foothold.

• High tensions simmer between the US and China, but a complete breakdown seems unlikely barring a major geopolitical crisis. Deep economic ties act as a safety net, minimizing supply chain disruptions and potentially creating space for a gradual thaw. Upcoming high-level visits, like Treasury Secretary Yellen’s expected trip to China next month, highlight the ongoing communication between the two countries. This trend is likely to continue, especially as China grapples with its economic slowdown. Nevertheless, we anticipate encountering occasional obstacles as both major economies strive to maintain their economic influence.

Other News: A major bridge in Baltimore collapsed late last night after a cargo ship collided with one of its supports. While there’s no indication of this being a deliberate act, authorities will likely conduct a thorough investigation in the coming months. Florida passed legislation to prevent minors under 14 from accessing social media, in another sign of the growing scrutiny of US tech companies.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a note on Congress’s passing of the last funding bills for the federal government on Friday and the resulting political clashes in the Republican Party.  We next review a wide range of other international and US developments with the potential to affect the financial markets today, including an aggressive new European Union antitrust probe into several top US technology firms and new data showing strong investor interest in US corporate bond funds.

US Politics:  On Saturday, the Senate passed the last of the bills funding the federal government through the end of the fiscal year on September 30, sending the bills to President Biden to sign into law to avoid a partial shutdown of the government.  Despite that victory, passage of the bills in the House on Friday with almost unanimous support from the Democrats and a minority of the Republicans has left the chamber in disarray.  As a result, the Republican majority in the chamber has narrowed to the point where the Democrats could take control.

• Far-right, hardline Republicans in the House are enraged that Speaker Johnson allowed a vote on the spending plan that was a compromise agreed to by President Biden and House leaders last spring. Republican Rep. Marjorie Taylor Greene of Georgia filed a motion to vacate the leadership, serving notice that Johnson could be ousted.
• Perhaps more important, Republican Rep. Mike Gallagher of Wisconsin announced he will leave Congress early in mid-April. That will leave the Republicans in the House with a majority of just one, meaning they could easily fail to push the Republican agenda in the chamber and could lose their majority if just one more Republican member leaves Congress early.
• To the extent that voters see the Republicans in the House as dysfunctional, the drama is a reminder that former President Trump does not necessarily have a lock on the November election, despite current polling showing that he has a slight advantage in public support. It remains too early to tell whom the next president will be.

European Union-United States:  The European Commission today announced it is launching official antitrust investigations into US technology giants Apple, Meta, and Google owner Alphabet. The probes are based on the EU’s new Digital Markets Act, which aims to limit the market power of big, on-line “gatekeeper” platforms. They will focus on whether the firms favor their own apps and how they use personal data for marketing. The probes will raise regulatory risks for a range of technology companies operating in the big European market.

Japan-United States:  The Financial Times said yesterday that the US and Japanese governments are preparing to make the biggest upgrade to their security relationship since their mutual defense treaty was signed in 1960.  The moves, which are aimed at more effectively fighting China in case of a conflict, will focus on giving US commanders in Japan greater operational authority to improve US-Japanese joint operations.

China-United States:  In yet another sign of economic decoupling brought on by US-China tensions, Beijing has issued new procurement guidelines that will phase out the use of foreign technology in government computers and servers.  For example, the new rules will outlaw computer chips from Intel and AMD, as well as operating and database software from Microsoft.  Instead, the government will seek to buy more Chinese-made technology, further limiting Chinese market opportunities for Western companies.

China:  In his keynote address to the China Development Forum yesterday, Premier Li Qiang tried to assure top foreign business leaders that the government is focused on removing obstacles to foreign investment in China.  Li specifically mentioned key issues such as fair market access, public contracts, and cross-border data flows.  Nevertheless, we suspect that the range of entrenched structural headwinds in China will continue to weigh on foreign investment in the coming years.

Russia:  The death toll from Friday evening’s attack by Islamic State on a crowded concert near Moscow has now surpassed 130.  Russia officials say they have arrested 11 people involved in the attack, including the attackers themselves.  Importantly, Russian officials continue to push a narrative that the Ukrainian government was involved, potentially with the intention to use the attacks to justify stepped-up aggression against Ukraine.

• Despite a laudable US effort to warn the Russians about the attacks ahead of time, we have seen little or no indication that the Kremlin respected the warnings or appreciated the US effort to avert civilian casualties.
• The fact that the attackers were able to carry out their plans despite the US warning to Russia suggests the Russian security services did not take the US warnings seriously and/or were incompetent in trying to stop the attacks.

Brazil:  New reporting shows left-wing populist President Lula da Silva is stepping up his interference in major companies.  For example, Lula reportedly forced partially state-owned oil giant Petrobras to backtrack on a plan to issue extraordinary dividends earlier this month.  The move helped push the company’s stock price by some 10% in a single day.  The moves are reviving concern that state intervention will eventually undermine Brazilian economic growth and prompt investors to flee the market.

US Bond Market:  New data from fund tracker EPFR shows investors have channeled about $22.8 billion into exchange-traded funds focused on corporate bonds so far this year, marking the first positive year-to-date inflows since 2019.  The inflows appear to reflect investors hoping to lock in high yields ahead of the Federal Reserve’s expected interest-rate cuts later this year.

US Media Industry:  Axios today carries an interesting article showing that the common news sources of the past have splintered into at least a dozen new information “bubbles” favored by different types of people.  For example, the report describes the “Instagrammers” bubble as consisting mostly of young to middle-aged women in college and the professional class.  In contrast, it describes the “Right-wing grandpas” bubble as mostly male older people who still watch Fox News, especially in prime time.

• It can be fun to read the article and ask yourself which bubble you fit into, or which bubble your family members or co-workers favor.
• On the other hand, the article illustrates the cleavages and mutually exclusive information sources that are driving political discussions these days. As people sink into their own bubble and keep themselves insulated from alternative viewpoints, the concern is that the new media landscape increases polarization and makes the country harder to govern.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Stocks have pulled back from their recent highs after the Federal Reserve meeting, while the University of Oakland is writing its Cinderella story after upsetting powerhouse University of Kentucky in the NCAA tournament. Today’s Comment examines why the recent global rate shift has us concerned about the market, how ongoing regulatory risks continue to impact big tech companies, and what the potential consequences of China’s economic struggles are for other countries. As always, we wrap up with a summary of international and domestic news.

Cuts Aren’t Guaranteed: All G-7 central banks have signaled a potential shift in monetary policy this year, but investors should remain patient before taking on risk.

• The Bank of Japan stands alone in its monetary policy. It recently raised rates but signaled a pause in tightening, aiming to keep rates accommodative. In contrast, all other major central banks are shifting towards looser policies. The Bank of England, European Central Bank, and Federal Reserve all hinted at potential rate cuts starting in June. Meanwhile, the Swiss National Bank took the most aggressive action, implementing its first rate cut in nearly a decade. The decision by rate-setters to adjust their policy language is likely to pave the way for looser financial conditions.
• Central banks’ dovish tilts have triggered a global decline in interest rates, paradoxically strengthening the US dollar. Expectations of a robust US economy and the Fed’s potential to maintain a tighter monetary policy stance are driving this rally compared to its peers. A strong dollar poses a challenge for foreign central banks, as it can lead to higher import prices, particularly for energy-related goods. Upward pressure on inflation could force them to choose between supporting their economies with lower rates or raising rates to combat inflation, potentially hindering growth.

• The recent global equity rally rests on a precarious tightrope — a soft landing for the US economy and a mild or brief recession in other developed economies. While policymakers and the market seem confident in a central bank pivot by June, a more cautious approach is warranted for investors. The US economy’s continued strength suggests the Fed may delay rate cuts until inflation shows clearer signs of abating. This, in turn, could lead other central banks to hesitate with aggressive rate reductions, potentially undermining the current market optimism. As a result, the recent rally may be short-lived.

Tech’s Boogie Man:  Recent lawsuits against Apple exemplify the significant regulatory risks facing the dominance of the Big Tech 7.

• Apple is facing mounting legal challenges. The US Department of Justice has filed an antitrust lawsuit, accusing the tech giant of stifling competition by restricting access to hardware and software features. This follows similar action from European regulators who charged Apple with non-compliance with the Digital Markets Act, alleging the company locks consumers into its service ecosystem. These legal battles, along with the potential for hefty fines and litigation costs, have weighed heavily on investor sentiment, contributing to an almost 8% year-to-date decline in Apple’s stock price.
• The legal challenges facing Apple exemplify a growing trend of government intervention in the tech sector. One contentious issue is the potential for governments to restrict sales of cutting-edge semiconductors to rival nations. The US, for instance, has implemented measures limiting the supply of such semiconductors to China, aiming to curb its technological advancement. Companies like Nvidia, which previously relied on China for a significant portion of its data center revenue, have had to reduce sales. Additionally, lawsuits regarding copyright infringement, such as those filed by the New York Times, could further dampen the enthusiasm of firms seeking to profit from generative AI.

• Tech giants facing legal scrutiny can weather initial skirmishes, but protracted legal battles lasting years loom large. Unfavorable rulings will likely trigger a flurry of appeals, further bogging down the process. Even absent a final verdict, these lawsuits can be a strategic nightmare, forcing companies to make temporary business adjustments that could erode their competitive edge. This is already playing out, with Apple recently lowering app sales commissions and allowing developers more payment flexibility in response to regulatory pressure. This trend is likely to continue and impact other major tech companies as well.

Yuan Breaks Threshold: A strengthening dollar and a production surplus could trigger heightened scrutiny of Chinese exports.

• The yuan (CNY) plunged to a four-month low after China’s central bank loosened its grip on the currency Friday, setting the dollar peg above 7.10 CNY. This move, likely driven by a strengthening dollar and soft data, weighed on the Chinese currency. The move fuels speculation of imminent stimulus to tackle slowing growth, partly caused by the property sector’s debt burden. The central government’s recent spending surge aligns with this, potentially aiming to alleviate pressure on local governments struggling with the ongoing property crisis. Finance Ministry data shows general public expenditure has surged 14% year-over-year, the fastest pace in over five years.
• China’s drive to boost growth is stoking fears of a wave of cheap exports, which may be particularly damaging to electric carmakers. Tesla underscored these concerns on Friday, announcing production cuts in China due to their inability to compete with lower-cost rivals. In response, both the EU and US are taking steps to shield their domestic industries. EU lawmakers are crafting legislation that could impose tariffs on Chinese electric vehicles (EV) by November. The US, already imposing a 27.5% import tax on Chinese EVs, is contemplating a significant increase, potentially reaching a staggering 125% of a vehicle’s value.

• China’s economic slowdown presents a multifaceted global challenge. While a surge in Chinese exports might provide temporary relief from inflationary pressures for some countries, it could trigger protectionist responses from others seeking to shield domestic industries and jobs. Furthermore, a significant portion of these exports are likely to be directed towards Belt and Road Initiative participant countries. BYD, for instance, has struggled in developed markets but remains the top choice for EVs in Brazil and Thailand. This suggests that China’s overproduction issue may continue to exert downward pressure on global prices, potentially harming Western companies indirectly.

Other News: Reddit’s IPO burned bright in a sign that investors are warming up to riskier bets. The recent decline in interest rates has fueled a tech spending spree, with companies taking advantage of cheap debt to refinance loans. Meanwhile, investors are actively acquiring corporate debt, seizing the opportunity for high yields before the Fed potentially cuts interest rates. This surge reflects a growing belief that rates have plateaued and are headed downward.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Stocks are rallying this morning as investors remain optimistic about the Fed achieving a soft landing. In sports news, March Madness tips off today, and we’re calling a win for the University of North Carolina. Today’s Comment dives into key issues: analyzing the latest FOMC meeting, exploring the budget debates among lawmakers, and examining the recent shift towards military assertiveness by US allies. As always, we’ll keep you informed with a roundup of international and domestic news.

Powell’s Punt: The Federal Open Market Committee’s (FOMC) decision paves the way for a potential rate cut in June; however, it may hinge on the strength of the labor market.

• Despite maintaining a cautious monetary policy, the FOMC signaled a brighter view of the US economy. In their latest decision, they opted to hold the target range for the federal funds rate between 5.25% and 5.50% and continue its balance sheet runoff. Nevertheless, a shift in their economic outlook is evident. FOMC projections show increased optimism, with GDP growth forecasts for 2024 revised upwards from 1.4% to 2.1%. Additionally, the unemployment rate is expected to dip slightly, from 4.1% to 4.0%. Notably, inflation projections remain unchanged, suggesting policymakers believe this economic uptick won’t significantly impact price pressures.
• The market initially welcomed the FOMC’s announcement, but a deeper analysis suggests a potentially hawkish undertone. Although the median dot plot remained flat at 4.625%, a rise in the weighted average from 4.70% to 4.80% signaled a slight shift among some policymakers. This could stem from concerns about the persistent tightness in the labor market, which might hinder progress toward the Fed’s 2% inflation target. Reinforcing this, Federal Reserve Chair Jerome Powell hinted during the press conference that persistently strong employment data could lead the central bank to hold interest rates higher for a longer period than currently anticipated by the market.

• The Fed’s decision on a June rate cut remains uncertain. While they haven’t committed to it, our baseline expectation is a cut if they aim to deliver on their projected three reductions this year. Thus, the strength of the employment data will be a key factor. If the US continues adding jobs at a solid pace, exceeding 180,000 per month, the Fed may delay easing policy, especially with inflation still above its target. However, to maintain political neutrality, the central bank might delay its first rate cut until July at the latest. This would keep them on track for three total reductions this year, with the other two likely occurring in the November and December meetings.

Slash Entitlements: Lawmakers are setting their sights on benefit programs as a potential area to address the government’s budget deficit.

• The Republican Study Committee (RSC), a conservative group within the Republican Party, has proposed a plan to ensure the long-term solvency of social programs. This proposal includes raising the Social Security retirement age, tightening work requirements for food stamps, and capping unemployment benefits based on prevailing wages, possibly around $15 per hour. While immediate passage seems unlikely, the RSC plan reflects a growing emphasis within the Republican Party on reforming entitlement programs. This aligns with recent comments by former President Trump, who called for streamlining Social Security to address potential inefficiencies. The Republican budget proposal is expected to reduce outlays by $14 trillion over the next decade.
• This plan addresses the challenge of the national debt’s sustainability through the implementation of rigorous spending controls, a matter both political parties are exploring alternative approaches to resolve. Democrats aim to reduce costs by allowing the expiration of the Trump tax cuts in 2025 and by increasing taxes on high-income individuals. President Biden has indicated his intention to raise taxes on individuals earning over $400k annually and to elevate corporate taxes from 21% to 28% should he be re-elected. This projection suggests Biden’s plan could generate nearly $5 trillion in additional revenue over the next decade.

• Austerity measures, including tax hikes and cuts to social programs, could free up resources to improve the fiscal balance. However, this approach faces significant hurdles. Public spending makes up a nearly a quarter of GDP, a substantial portion. Additionally, Social Security costs are projected to rise further by 2033, and these programs are essential for many voters. Tax increases are likely to encounter resistance from lobbyists representing groups who would shoulder the burden. While we remain optimistic that the government will take the necessary steps to stabilize government spending, we also acknowledge there may be bumps along the way. That said, we remain confident that defense spending will be fairly insulated.

Foreign Defense:  With growing concerns about international conflicts, key US allies are taking a harder look at their defense capabilities.

• The UK and Australia fortified their defense partnership on Thursday with a pact addressing China’s growing influence in the Indo-Pacific. This agreement streamlines troop deployments, further solidifying the ties established by the 2021 AUKUS defense pact. Meanwhile, in response to Russia’s escalating threat on the European continent, French President Emmanuel Macron has revived plans for EU defense bonds to bolster Europe’s military capabilities. However, this proposal faces an uphill battle as Germany remains staunchly opposed. Nonetheless, these moves reflect a broader Western trend of unease over rising threats from both Russia and China.
• The Ukraine invasion in 2022 marked a turning point for Western priorities. Previously, these nations prioritized domestic spending on social programs, often neglecting defense budgets. The war has triggered a significant shift. Western powers are now demonstrably reorienting their focus towards bolstering their own defenses and supporting allies in a climate of heightened security threats. This is evident in Europe’s recent surge in support for Ukraine, which has had a cascading effect, revitalizing the Continent’s defense industry. European defense stocks have surged 21% year-to-date, outperforming the US defense sector which has gained 5%.

• US allies, particularly in Europe, are investing in their own defense industries. Though, established US firms like Lockheed Martin, General Dynamics, and Northrop Grumman are well-positioned to remain key partners in the near future. These giants boast a proven track record of fulfilling allies’ growing demands for advanced weaponry. To capitalize on the expanding global defense market, they may look to expand through acquisitions and partnerships in other markets. This trend towards increased defense spending across the Western world bodes well for the industry as a whole.

Other News: Central banks in the West are taking a dovish turn, with the Bank of England signaling a potential rate cut later this year, and the Swiss National Bank taking a surprise step by lowering rates immediately. Yemen has told Russia and China that their ships will not be targeted; the move is further evidence of Iran’s growing influence on the conflict in the Red Sea. President Biden’s continued focus on reducing housing costs underscores the growing political importance of affordability.

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