Cloudy With a Chance of More Expensive Meatballs

Opposite Day

The stock market is supposed to be an efficient discounting mechanism, but it felt like a pinball machine last week. Tuesday saw Tesla miss its revenue and profit expectations, and Wednesday’s Meta earnings release was the best in its history. However, Tesla spiked up over 10%, while Meta fell by more than 15%. Worse, Meta’s stock plummeted out of investor fear that the company’s AI spending is out of control.

Meta is no stranger to this reaction: Its metaverse spending and the development costs for Reels and Stories short videos were all met with initial investor dissatisfaction. The question remained if the reaction was company-specific, or if investor sentiment had generally reversed. If investors were truly becoming impatient about when the big AI spend would generate revenue, it would represent a big reversal. The bullish enthusiasm over AI ushering in a new era of enhanced productivity pushed the stock market to new highs. This uncertainty led to a jittery market Thursday, as people became worried about the potential of a negative reaction to Google and Microsoft earnings the following day. Thankfully, the worry was limited to Meta because when Microsoft and Google exceeded expectations, their stock prices were bid up strongly. In fact, Google had a huge jump of 20% after its announcement, translating to an increase in its valuation (market capitalization) of $320 billion. To put that number in perspective, 96% of all companies in the S&P 500, the stock index containing the largest companies in the world, have a market cap of under $320 billion. Thursday afternoon saw Google move the equivalent of an entire Oracle or Home Depot.

While we are relieved that investors are not becoming impatient with seeing immediate profits from firms’ AI buildout, the schizophrenic action in the world’s largest stocks is a sign of heightened speculation that can be a sign of a very fragile market. Topping processes can take months and can even lead to new highs before a major selloff, but it is a sign of concern.

Fahrenheit 161

The Dollar-Yen exchange rate is 155, meaning it takes 155 Japanese Yen to buy one dollar’s worth of goods. The Yen is at its weakest level relative to the Dollar in 35 years, and Japan’s Ministry of Finance (MoF) will try to stabilize the decline before it gets really out of hand. They can try to strengthen the Yen by entering the foreign exchange market and sell the U.S. Dollar and buy Yen. Currency intervention is rare and can create very volatile conditions in the foreign exchange market that can cascade into other asset markets globally Our own Treasury Secretary Janet Yellen weighed in, almost telling Japan not to do so when she stated that currency intervention is “acceptable only in very rare and exceptional circumstances.”

Takeo Ochi, the secretary-general of Japan’s ruling Liberal Democratic Party (LDP) suggested that an exchange rate of 160 or even higher could push the MoF into action. When currency traders receive a specific exchange rate target for intervention, they assume they have a free pass to push the market to that boiling point.

The weak Yen is a symptom of the large interest rate gap between Japan and the rest of the world. Japan’s central bank, the Bank of Japan (BoJ), has not acted fast enough, nor has it communicated a clear path to higher interest rates. Japan’s Consumer Price Inflation (CPI) report came in far below expectations, matching its lowest level in two years late Thursday. This pushed USDJPY up toward 157 because the specter of lower inflation makes the BoJ even more reluctant to raise rates. The central bank had a previously scheduled meeting shortly after the CPI release and kept rates unchanged. The BoJ will need to raise rates before any sense of calm is re-established. A strong dollar can destabilize, adding to the volatility across global stock markets, so this is another factor that U.S. equity traders must consider.

Inflation Impediments

Three pieces of inflation information were released last week, and none were positive. Thursday’s GDP number contained a toxic combination of slow growth (1.6% vs. the 2.5% consensus) coupled with high inflation. The core GDP deflator (excluding food and energy) reported a 3.7% inflation rate, above expectations of a 3.4% annual result. Furthermore, the report showed a sharp 4% increase in services spending, which will push the prices of services higher; services inflation has been the part of general inflation that has refused to drop fast and is of the highest concern to the Federal Reserve.

Friday’s PCE inflation data for March also came in above expectations, reinforcing investors’ views that the Fed will most likely lower interest rates once this year. The 3-month annualized core PCE inflation rate jumped to 4.4%, reminiscent of its rise in 2021 when core inflation’s increase forced the Fed to raise rates in 2022.

The data helped push the 10-year Treasury note yield to its highest level since October 2023, hitting 4.70% after being as low as 3.80% in February. The sharp ramp in rates means that monthly financing charges will rise and make the affordability of big purchases such as cars or homes even more unreachable for so many consumers. The GDP report showed that personal consumption of big-ticket durable items fell by 1.2% last quarter, reflecting not only the weight of higher inflation diminishing the average paycheck’s purchasing power but also those burdensome financing costs. Because this data is from January through March, when interest rates averaged 4.20%, the recent interest rate spike will darken the consumer's outlook even further.

What To Look for This Week

1. Alphabet Soup. QRA: Quarterly Funding Announcement Wednesday, May 1. Not well known to the public but should be the most important release of the week because it can be a big market mover over time. The balance between the supply of Treasury Bills relative to longer-maturity Treasury Notes and Bonds scheduled for the upcoming quarter impacts long-term interest rates and has a major influence on stock prices. Secretary Yellen has communicated that there will be little change from Q1’s auction schedule, but any surprise will cause an equity market reaction.

2. FOMC: Federal Open Market Committee meeting Wednesday, May 1. No rate change is expected during the meeting, but the FOMC could announce a reduction in the amount of Treasuries and Mortgage-Backed securities they have been buying under their Quantitative Tightening (QT) program. The markets are only pricing in a little over one rate cut for this year, and we will see if Chairman Powell tries to change that view at his press conference.

3. NFP: Nonfarm Payroll Employment Report Friday, May 3. With last week’s elevated inflation data, we will be looking at wage inflation, measured by the year-over-year growth in Average Hourly Earnings. It remains quite high despite having fallen from 5.6% to 4.1% over the last two years.