Macro

This week, risk assets came under pressure as Wednesday’s CPI report exceeded expectations, marking 3rd increase in a row. Since the FED is facing three reports now, it will be easier to argue for the rate cuts before the fall if significant CPI improvements are in the upcoming April and May reports. The increases, however, came from the ‘stubborn’ components such as shelter and auto insurance, while the median CPI component has not only 1.7% YoY inflation. While CPI is more sticky, PPI is more cooperative. Softer PPI indicates that PCE, which is FOMC’s preferred inflation gauge, will also be softer (PPI is a leading indicator of consumer inflation because it reflects price changes in output sold by domestic producers, which will eventually be passed on to consumers).

Higher-than-expected inflation data caused the dollar to rally and have its strongest single-day and largest weekly performance since 2022. The dollar strengthened mostly due to pushing off expectations for interest rate cuts. However, appreciation was also caused by the divergence between tight monetary policy and loose fiscal policy, which is a recipe for currency appreciation. The secondary impact came from the dovish ECB and disappointing credit data from China.

Rates

The unexpected CPI surge significantly affected US rates, which saw the largest single-day increases in recent years. As a result, the 10Y rate is now above 4.50%, reflecting a 22 bps increase this week.

Despite CPI’s surprise to the upside, all the recent commentary suggests that rate changes are pushed off to the future rather than up. Although the probability of June and July cuts is at least 50%, it may come back up again if April and May prints show improvement.

Critics are quick to point out that the inflation-control victory lap during the December meeting was premature. Bank of America and Deutsche Bank are now predicting that the first cut will be in December (rather than in June). Although real rates look attractive, the risk of rates is still to the upside, with a potential retest of the October heights of around 5%.

Larry H. Summers, Economist and former US Secretary of the Treasury, went so far as to say that investors “have to take seriously the possibility that the next rate move will be upwards rather than downwards.” Bond bears are pointing out that if inflation remains sticky, we might see bearish steepening with a 10Y rise to a long-term resistance line of 5.3%, last achieved a decade ago, back in 2025.

Upward pressure on yields is also related to the decrease in international demand, which has been mentioned many times in recent weekly updates. The most significant would be the impact of Japan, which is the biggest foreign holder of treasuries. This week, the Japanese Yen pushed through the 152 JPY/USD level, previously enforced by policymakers. If the Yen weakens further, we might see intervention from the BOJ. This will be a negative signal for US treasuries, as BOJ would sell them to cover their shorts. Given overall positioning, this might generate a lot of pressure on US treasuries as the Japanese own treasuries, which are hedged to Yen, and foreign investors own Japanese stocks, which are hedged to the dollar.

Credit

The supply of corporate credit remains small as companies are deleveraging due to the higher cost of debt. There are simply not enough bonds coming to the market to answer investors’ demands, leading to spread compression and a shift in investors’ focus towards total yields. For this reason, spreads remain tight; however, the CDS High Yield index has moved significantly higher. Spreads do not always directly translate to more investment risk as, thanks to the compensation from the higher rates, there is more room for an error.

The leverage loans market carries more risk, as companies that borrow on floating rates need to see rates coming down before they can start returning positive cash flows. These companies also need more capacity to deliver their balance sheets and are more sensitive to the business cycle.

Equities

US equities have declined this week after two solid quarters of double-digit gains. Small caps declined more than large caps as smaller company valuations are more sensitive to interest rates. Although all significant indexes sit above 50 DMA, 56% of individual stocks have already broken down from the positioning perspective.

Analysts argue that SU stock market multiples are too rich now when the rate cuts are pushed off, further into the future. This makes intuitive sense based on market behaviour over the last 20 years, as the average PE is now 20.6 compared to a 5-year average of 19.1 or a 10-year average of 17.8. However, looking at the long history of the US market, when rates are within the 4 to 5% range, the median PE ratio is 20x (although historical rates were much higher than in the last 20 years). Outside of the mega-cap tech market, Canadian PE is 16x. Assuming earnings on S&P can increase to 270 to 280 in 2025, then with a forward multiple of 20, we can exit the year with S&P hitting 5,400 to 5,600 points.

Companies only started confirming their Q1 earnings, but so far, 83% reported positive EPS and 53% positive revenue surprises. This should also be the third quarter in a row of earnings growth. Six sectors reported YoY earnings growth, led by Utilities, Information Technology, and Communication Services, and five reported a decline, led by Energy, Materials, and Health Care (Source: Factset). It’s worth noting that financials reported an 11.6% positive earnings surprise, leading to.