Dear Friends,
The financial markets experienced a rocky start to 2024, which might raise some concerns initially. However, this is a natural short-term correction after a two-month rally at the end of 2023 as short-term investors harvest gains in the new year. Find out more about what is driving the markets in this week’s newsletter.
Economy, Geopolitics, and Commodities
1. Unemployment rate held steady at 3.7%
According to a non-farm payroll report released by the Bureau of Labor Statistics this Friday, employers hired at a solid pace in December 2023, capping a year of steady gains for a job market that continues to defy expectations and remains a bright spot in a gradually cooling economy. The U.S. economy added 216,000 jobs last month, the Labor Department reported Friday. That was larger than November’s gain of 173,000 and better than forecasters were expecting. Hiring was revised down in both October and November. For all of 2023, employers added 2.7 million jobs, a slowdown from 2022, but a better gain than in the years preceding the pandemic. Hiring was broadly based last month, with healthcare and government leading job gains. Transportation and warehousing employees shed jobs. The unemployment rate in December held at 3.7%. The jobless rate began 2023 at 3.4%, matching lows not seen since the late 1960s, and remains low despite inching higher late last year. Wages rose a healthy 4.1% last month from a year earlier. More broadly, there are signs that the tight labor market conditions that prompted employers to offer robust pay raises in early 2023 continue to wane.4
The labor market’s slowing but steady pace during 2023, coupled with a sharp slowdown in inflation, has fueled optimism that the economy can achieve a so-called soft landing. That would mean inflation eases without a recession. Federal Reserve officials have signaled they are comfortable for now maintaining their benchmark federal funds rate at a 23-year high as they await more evidence that inflation is falling back to their 2% target. At their meeting last month, most officials penciled in at least three rate cuts this year, a sign the central bank is done lifting rates. Friday’s report will do little to alter that calculus and keep the central bank on track to hold rates steady at its next policy meeting, Jan. 30-31. It suggests the labor market is no longer at risk of overheating, particularly as private-sector hiring has eased over the past few months. But it also doesn’t point to material weakness that might move up the Fed’s timetable for cutting rates.1
2. Fed Minutes Suggest Rate Hikes Are Over
Federal Reserve officials thought they were done raising interest rates when they decided last month to hold them steady, but minutes of the meeting didn’t reveal a meaningful debate about when to start lowering rates. While nearly all officials anticipated policy rates would eventually be lowered before the end of this year, the written account of the Dec. 12-13 meeting, released Wednesday, underscored heightened uncertainty over how to navigate the next interval of monetary policy after the most rapid increase in interest rates in four decades. Some policymakers revealed unease about leaving rates too high for too long. They highlighted “the downside risks to the economy that would be associated with an overly restrictive stance,” the minutes said. They flagged the risk that a slowdown in the labor market could “transition quickly from a gradual easing to a more abrupt downshift in conditions.”.
Fed Chair Jerome Powell’s news conference after the meeting sparked some confusion. Comments from Powell—along with projections released after the meeting penciling in three rate reductions this year—indicated the Fed’s next move was more likely to be a cut even though the central bank maintained written guidance that said officials were more attentive to economic risks that would require higher rates. As a result, markets ratcheted up their bets on rate cuts this year, sparking big stock- and bond-market rallies to close out 2023. Investors expect the central bank to begin lowering rates at its second scheduled policy meeting this year, in March. The Fed’s next meeting is Jan. 30-31. The minutes indicated increasing comfort that the Fed’s rate increases are working. References to “unacceptably high” inflation that had appeared in previous minutes weren’t included in the latest account. Still, the minutes suggest that officials could become nervous if markets rallied too much by easing financial conditions in a way that could make it harder to slow the economy and keep inflation moving down.1
3. The Hidden Force Pushing Mortgage Rates Down
Average 30-year fixed mortgage rates have been higher than usual relative to the benchmark Treasury yields they typically track. But that extra differential, or spread, has been shrinking for eight straight weeks. It is now at its lowest since March. The 30-year mortgage rate has fallen by more than a percentage point recently to 6.62%, according to data released Thursday by mortgage giant Freddie Mac. The shrinking spread between that and the 10-year Treasury yield amounts to roughly one-sixth of the decline. (Treasury yields have also fallen sharply.) The spread is still far larger than its historical average. But its downward trend is giving mortgage rates an extra push lower. It is a boon to would-be home buyers who have been sidelined by high borrowing costs, as well as to hard-up mortgage lenders and real estate agents.
The reason the spread exists in the first place has to do with the machinery behind the home-lending industry. Once loans are extended by mortgage companies, they are typically packaged into bonds and sold to investors. Investors demand more yield on mortgages than Treasurys to compensate for the risks of holding them. That gets baked into the rate borrowers receive. These days, investors have lots of reasons to demand more yield. For one, there is the risk that mortgages extended today won’t be around tomorrow. If rates fall, as many expect, homeowners will refinance into lower-rate loans, cutting off investors’ streams of income. The biggest buyers of mortgages, such as banks and the Federal Reserve, have also been buying less since the Fed started lifting interest rates in early 2022 to combat skyrocketing inflation. The central bank last month signaled it is likely to finish raising rates and could cut rates this year as inflation has been falling and the economy has remained strong. That is reviving investor demand for mortgages somewhat and pushing down the spread.1
4. Eurozone Inflation Rose Less Than Expected
Eurozone inflation rebounded in December, but by less than expected, potentially fueling further speculation that the European Central Bank could soon signal its readiness to cut interest rates. The bloc’s consumer price index—a measure of the cost of goods and services—rose 2.9% on the year, from 2.4% in November, according to preliminary data published by the European Union’s statistics agency Eurostat on Friday. Although a bounce back in inflation was expected, it came in lower than economists expected in a poll by The Wall Street Journal, which saw prices rising by 3.0% on the year. Inflation had fallen for five straight months until November.
Meanwhile, core inflation—which removes volatile energy, food, alcohol, and tobacco prices and is watched as a reflection of underlying inflationary trends—dipped to 3.4% in December from 3.6% in November. That reading was again below the consensus, at 3.5%. The cooler-than-expected readings for both headline and core inflation could lead to calls for earlier rate cuts by the ECB, amid stronger disinflationary signs and that the rate will soon close in on the central bank’s 2% target. In a further signal of easing price pressures, industrial producer prices were down 0.3% in November, according to Eurostat data also released Friday. Money markets are pricing in a first 25-basis-point rate cut in April, data from Refinitiv says. The ECB held rates at its last meeting in December, with the key deposit rate at 4.0%. December’s rebound in headline inflation was mainly driven by energy costs, which fell at a much slower pace in December than in November. Energy prices were down 6.7% on year in December, from 11.5% the prior month, Eurostat said, likely driven by base effects from German government assistance introduced late in 2022 that cushioned gas and heating bills in Europe’s largest economy.1
5. 2024 Could Be the Year of the Yen
The Japanese yen has been one of the worst-performing currencies of the past couple of years. It could do better in 2024. The yen has lost around 20% against the dollar since the end of 2021, underperforming other major currencies. Japan’s central bank kept its ultralow interest rates while most of its peers have been raising rates aggressively. Higher yields outside of Japan have driven the currency lower and lower. While inflation has picked up in Japan – as almost everywhere else – it remains low compared with other developed economies. Japan’s core inflation rate, which excludes fresh foods, was 2.5% from a year earlier in November, down from 4.2% at the beginning of 2023. Though that is already above the Bank of Japan’s 2% inflation target, the central bank has been unwilling to raise interest rates too quickly, fearing a hit to the economy.
The BOJ may eventually still tighten its monetary policy, especially if it judges that inflation has moved sustainably above its target. The central bank has already made a couple of tweaks to its “yield-curve control” policy, which seeks to keep its long-term bond yields low. The yen has risen around 7% against the dollar since mid-November, partly as traders expect the BOJ to give up its negative interest-rate policy sometime in 2024. Yet one of the biggest supports for the yen in 2024 will likely come from the Federal Reserve. Its rate-increase cycle has likely come to an end already, and the central bank has indicated cuts could be coming. The yield differential between 10-year government bonds in Japan and the U.S. has narrowed by almost 1 percentage point in the past two months, just because of plummeting U.S. bond yields. Japanese bond yields have, in fact, also fallen during the period. Japan stayed put when every other major central bank was raising interest rates, betting it could withstand negative pressure on the yen. That gamble now seems to have paid off.1
UVA Community News
It’s great to see the UVA community making an impact worldwide! Check out this article to learn about Darden students’ experience in Morocco following the 2023 earthquake.
Financial Markets
1. S&P 500 Rises After Jobs Report
Stocks inched higher Friday after the jobs report showed solid hiring in December, though they logged losses for the week. The broader index rose 0.18% to end at 4,697.24, while the Nasdaq Composite added 0.09% to finish at 14,524.07. The Dow Jones Industrial Average ticked higher by 25.77 points, or 0.07%, settling at 37,466.11. The three major averages notched their first negative week in 10, with the Nasdaq suffering the biggest decline at 3.25% — its worst weekly performance since September. The S&P 500 and Dow dropped 1.52% and 0.59%, respectively.2
The 10-year Treasury yield rose above 4%, up from 3.99% on Thursday. It climbed after the jobs report. The yen extended its decline, weakening to around 145 a dollar. The Japanese currency has slid this week. Oil prices ticked higher, reversing Thursday’s losses. Brent finished the week just under $79 a barrel. European and Asian stock indexes mostly fell. Data showed a weaker-than-expected rebound in eurozone inflation. Shares of Verizon, Boeing, and Home Depot led the gains for the Dow Jones Industrial Average on Friday. The stocks were respectively up 2.3%, 1.8% and 1.2%. Seven of the index’s 30 stocks had gained 1% or more during Friday’s trading session. On the other hand, UnitedHealth Group, Proctor & Gamble, and Walmart were the biggest losers, respectively sliding 1.3%, 1% and 0.9%.3
2. Cognac Sets the EV Trade War Alight
Volkswagen and Stellantis might turn out to be bigger victims of China’s investigation into European liquor than Rémy Cointreau and Pernod. Beijing has launched an antidumping probe into brandy imported from the European Union. The idea that France is dumping cognac on China might seem laughable, but that didn’t stop investors from dumping cognac stocks on Friday. Shares in Rémy Cointreau, the company behind Rémy Martin, fell 15% in morning trading, while those of the larger Pernod Ricard, which makes Martell, were down 5%.
If the move makes little sense economically, the political logic is clear. In October, the EU launched its probe into the illegal subsidization of Chinese electric vehicles after pressure from the French government. Paris was itself being intensively lobbied by local carmakers, most vocally Stellantis, which owns the Peugeot, Citroën and Fiat brands as well as Chrysler in Detroit. Germany’s Volkswagen has as much to lose from an influx of Chinese EVs but, with a big Chinese business to defend, it has kept quieter. This explains why Beijing’s retaliation focuses on a French product that has become a luxury good in China. The country accounts for about 30% of the operating profit at Rémy Cointreau and 9% at Pernod Ricard, according to Citi. The largest cognac brand, Hennessy, is joint-owned by luxury giant LVMH and Diageo, spreading the pain. Their shares were both down about 2% on Friday.1
3. Netflix Considers Ways to Make Money from Videogames
Netflix has said it plans to be in gaming for years to come. Now the company is trying to figure out how to make money from it, a potential shift in strategy for the streamer. Executives at the streaming giant have had discussions in recent months about how to generate revenue from its games, according to people familiar with the discussions. Netflix games are currently free for all subscribers, part of a strategy to keep users coming back to the streaming service when their favorite shows are between seasons as well as to attract new fans.
Some of the ideas that have been discussed include in-app purchases, charging for more sophisticated games it is developing, or giving subscribers to its newer ad-supported tier access to games with ads in them, the people said. Such moves would mark a pivot for Netflix, which has resisted putting ads or in-app purchases in its games. “We want to have a differentiated gaming experience, and part of that is giving game creators the ability to think about building games purely from the perspective of player enjoyment and not having to worry about other forms of monetization, whether it be ads or in-game payment,” Netflix Co-Chief Executive Greg Peters told investors in April. Netflix encourages open debate internally on its strategy, which is a key pillar of its culture, and such discussions don’t mean the company will decide to monetize games. Netflix has been clear that its gaming strategy, which began in 2021 and so far, consists of mobile games that subscribers can download free, is a long-term bet.1
4. Cigna Nears Deal to Offload Medicare Business
Cigna is in advanced talks to sell its Medicare business in an about-face for the health insurance giant, which had been expanding its footprint in the fast-growing sector. Cigna, which has been running an auction for the business, known as Medicare Advantage, is now in exclusive talks to sell it to Health Care Service Corp. for between $3 billion and $4 billion, according to people familiar with the matter. Should there be a deal, it would mark a major expansion for HCSC, a big nonprofit health insurer that is the parent of Blue Cross Blue Shield plans in five states including Texas and Illinois. HCSC has long been a powerful player in its home states, but the deal would give it a significant Medicare business and far broader reach. Cigna is offering Medicare plans in 29 states for 2024.
Cigna is proceeding with the potential sale even though its talks to acquire Medicare-focused insurer Humana broke off after investors reacted coolly to the possible megadeal. Cigna said that it plans an additional $10 billion of stock buybacks. It is also expected to focus on smaller, so-called bolt-on acquisitions. Medicare Advantage, the private insurer version of the federal benefit program for the elderly and disabled, is a major growth engine for the managed-care industry. About half of Medicare beneficiaries are enrolled in the plans, and the numbers are projected to keep growing as more baby boomers turn 65 and become eligible for the program. Cigna has traditionally focused largely on administering health benefits for employers and a huge pharmacy-benefit manager as well as other health-services offerings under its Evernorth banner. In 2022, Medicare Advantage represented a small slice of Cigna’s total revenue of $180.5 billion.1
Sources:
(1) www.wsj.com
(2) www.bloomberg.com
(3) www.cnbc.com
(4) www.bls.gov
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Economic forecasts set forth may not develop as predicted.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
Investing in stock includes numerous specific risks, including the fluctuation of dividends, loss of principal, and potential illiquidity of the investment in a falling market.
Investing in foreign and emerging market securities involves special additional risks. These risks include but are not limited to currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.
Investment advice offered through Private Advisor Group, a registered investment advisor and separate entity from The Legacy Foundation.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
The Legacy Foundation and LPL Financial do not offer tax advice.
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