Despite ongoing Middle East conflicts, U.S. stock markets have recorded their first weekly gain since mid-February, with investors closely watching the outlook for tensions in the region.
For investors, the key question is whether this is merely a technical rebound following oversold conditions or the beginning of a more sustained recovery. Clues may emerge more clearly next week.
The prospect of interest rate cuts by the Federal Reserve appears dim. Recent U.S. data has been generally positive. Employment, retail sales, and consumer confidence figures all exceeded expectations, although the Chicago PMI and the March Services PMI have raised concerns about the economy.
Non-farm payrolls increased by 178,000 in March, recovering from an unexpected decline in February, while the unemployment rate fell from a recent high to 4.3%. Private sector hiring also stabilized and improved, with ADP employment rising by 62,000 in March, surpassing the market expectation of 40,000. The Fed's JOLTS job openings fell to 6.882 million from 7.24 million the previous month but were slightly above the expected 6.85 million.
On the consumption side, retail sales rose 0.6% month-over-month in February, a significant improvement from January's -0.1% and better than the market forecast of 0.4% growth. Core retail sales increased by 0.5%, outperforming both January's flat reading and the expected 0.4% rise. Meanwhile, the Conference Board's Consumer Confidence Index rose 0.8 points to 91.8 in March, beating the consensus estimate of 87.5.
On the negative side, the Chicago PMI fell to 52.8 in March, below the market expectation of 54.0. The final March Services PMI came in at 49.8, dropping below the 50-point threshold that separates expansion from contraction for the first time in three years. The Atlanta Fed once again lowered its real-time GDP growth estimate for the first quarter, revising it down from 2.0% last Friday to 1.6%. However, the market may need to wait several more weeks for economic data reflecting the impact of the Middle East conflict to draw firmer conclusions.
A senior economist at Oxford Economics noted that while the non-farm payrolls data was better than expected, it significantly overstates the sustainable pace of job growth. The end of strikes, seasonal factors, and a rebound after severe winter weather may have artificially boosted hiring in some sectors. The slight drop in the unemployment rate coincided with weakness in underlying components: both the labor force participation rate and household survey employment declined. As conflict-related shocks soften the labor market, the unemployment rate is expected to edge higher in the coming months.
This week, medium- and long-term U.S. Treasury yields retreated from recent highs, leading to a slight steepening of the yield curve. Compared to last Friday: the 2-year Treasury yield, closely tied to interest rate expectations, fell approximately 14 basis points to 3.794%, while the benchmark 10-year yield declined about 12 basis points to 4.305%.
Market expectations for the Fed's next policy move continue to point towards no change. Pricing in federal funds rate futures implies nearly an 80% probability that rates will remain unchanged by December. Currently, the probability of a Fed rate cut does not surpass the 65% threshold until July of next year.
The economist suggested that downside risks to the labor market have increased due to the conflict. As higher spending on gasoline begins to crowd out discretionary consumer spending, the conflict's impact on retail sales will likely be felt starting in March. However, he believes the Fed will likely look through the one-time inflationary effect of rising oil prices and proceed with two rate cuts this year to guard against potential future weakness in the labor market.
Can the Market Stabilize?
After a dismal first quarter, the three major U.S. stock indices posted their largest weekly gains in four months, ending a six-week losing streak. Investors are searching for reasons to hope that the Middle East conflict might be nearing a resolution.
Sector performance, according to Dow Jones Market Data, showed Communication Services leading the gains, surging 6.4% for the week, followed by the Technology sector, which rose 4.6%. Real Estate, Financials, and Materials sectors also performed strongly, each gaining over 3%. Industrials, Consumer Discretionary, and Healthcare sectors advanced more than 2%. Utilities and Consumer Staples posted modest gains. Energy was the only sector to close lower, falling 5.3% for the week.
The Chief Economist at BMO Capital Markets stated in a report: "The market has been swayed by nearly every development in the U.S.-Iran conflict, particularly every swing in oil prices. This oil price spike has triggered a record 26% surge in U.S. retail gasoline prices."
Notably, while near-month crude futures prices surged, with WTI crude rising to around $111 per barrel and the international benchmark Brent crude approaching $108, the October contracts for both benchmarks were priced around $80 per barrel. This suggests the market expects the current supply disruption to be temporary.
A market strategist at Baird commented, "Neither bulls nor bears have a clear direction in the equity market right now, but the October oil price indicates the market believes this crisis could be over by the fall."
Charles Schwab wrote in its market outlook that stocks experienced another week of sharp volatility.
"The investor still faces numerous unanswered questions: How long will the conflict last? How high will oil prices go, and for how long? Will the U.S. strike Iranian energy infrastructure? Will the U.S. deploy ground troops? What will be the net ultimate impact on global growth and corporate earnings growth? The market hopes for a relatively peaceful resolution with minimal casualties and limited damage to the global economy, but until then, sharp swings in stocks and news headlines are likely to persist." The outlook noted that next week brings two monthly inflation reports (CPI and PCE), but these figures might be largely ignored as they are lagging indicators, and inflation is expected to climb further in coming months due to higher energy prices.
The outlook suggested that, given the potential for military escalation, it is difficult to make further predictions when price action is driven by conflict headlines rather than economic and technical indicators. "However, last Thursday seemed to be the first challenge to the negative correlation between the S&P 500 and oil prices – WTI crude rose 11%, while the S&P 500 fell only 0.10%. This might be a positive sign for the bulls, but if the situation escalates next week, driving oil prices even higher, can equities maintain their resilience? This could serve as a bellwether for short-term direction."
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