Macro

After every major economic shock or recession, people tend to become more conservative, more price-sensitive and economically cautious, and they tend to save more. However, after the COVID, it was the opposite. People locked at home increased their good consumption and started speculating in financial markets; later, when they were allowed to socialize and travel again, they went on revenge spending. This increased consumption has fueled high economic growth and helped to recover towards the pre-pandemic GDP growth trend line quickly.

This behaviour was partially enabled by extraordinary fiscal stimulus and direct checks and partially due to reduced spending. Despite the recovery and strong economy, fiscal stimulus continues, and the M2 money supply remains $2.7 trillion above the pre-pandemic trend, although it has significantly declined from its peak.

Despite the declining money supply and potential reduction in the fiscal stimulus, most economists expect the US economy to grow strongly. Goldman Sachs is also bullish on the economy, and in its most recent forecast, it estimated 2.3% growth for the year, unemployment below 4%, and inflation of 2.1% by year-end.

Rates

The FED has moved from a “higher for longer” mantra to a “slower to lower” mantra, as it has shown more hesitancy to start the rate cut than the market expected.

At the end of 2023, the market projected a sharp fall in inflation and started to price aggressive rate cuts. However, with easing financial conditions and robust economic growth, the FED is not rushing to cut rates. Since then, the market has dialled back Fed cut bets and nearly aligned with the FED’s outlook of 3 rate cuts this year (the market’s current estimate is 3.4 cuts).

Rates are up this week, with all major developed countries raising money at rates sharply higher than in previous actions. This week’s $9 b auction of 30Y TIPS ended at a yield of 220 bps, the highest yield since 2010.

In January, we were getting closer to the 4% level on both the short and long ends of the curve, but then rates shot up about 50 bps, with 2Y at nearly 4.7% and 10Y at 4.3%. Some analysts expect a hike, but this scenario is highly unlikely without reaccelerating the inflationary pressure.

Credit

We see credit exuberance with a very tight spread and record issuance of over $60b last week (compared to $50b analysts’ expectations). As corporate fundamentals remain more robust than expected, there is much broad-based buying with an overarching for total yields. A lot of cash is coming into the credit market that tries to scoop up any issuance, with most of them being significantly oversubscribed. As long as the overwhelming expectation is that the rate cuts are imminent, the dip-buying mentality and high demand for credit will persist. Furthermore, as institutional investors try to lock in attractive rates for longer, they increase their demand on the longer end, flattening the curve and squeezing the term premiums.

Limited headwinds from the macro or fundamental side push credit spreads even lower, with spreads in specific sectors, such as industrials, at a 25-year low. Spreads are not only tight but also stable. Historically, when yields are high, the volatility of spreads has been low. Some view tight spread as a sign of credit investors’ complacency. Investors are measured by historically large amounts of credit enhancement built into transactions in order to absorb potential losses. Credit investors should be careful when buying paper from risky borrowers regardless of this additional protection. In the late cycle, it becomes more important to pick issuance with resilient value characteristics, such as a healthy balance sheet, a solid operating income and greater flexibility or refinancing.

Equities

This week, Nvidia experienced the biggest single-session market cap gain ($250B) in the stock market history, and because 3rd the most valuable US-listed company. Shares soared 16.4% thanks to incredible results that blew past analyst the aggressive analysts expectations again. Cheapmaker grew revenues over the last year by 265% on the back of the AI boom (EPS $5.16 adjusted vs $4.64 expected or net income of $12.9b and revenues of $22.10b vs $20.62b expected, while its revenues guide for the current quarter is $24b). NVIDIA has extremely bullish momentum with a 1.6 call-to-put volume ratio, with 115k call options traded on a day and 40k puts.

Remarkably, Nvidia single-handedly sparked a rally in global stocks, sending the US (S&P 500 and Nasdaq), European (Stoxx Europe 600), and Japanese (Nikkei 225) markets to all-time highs. The S&P increased by 2.1% on its best day since January, and the tech-heavy NASDAQ had its best day in a year and closed 3% up.

Despite the rally in most global markets over the last 12 months, their performance is far behind the US market. US stock market price performance is near the extreme peak compared to international equities. The US market is growing faster because of its dominance in technologies critical to driving global economic growth. A lot of good news has already been priced in, and risks are skewed to the downside.