• Nonfarm payrolls loom large
• Sticky inflation lowers the odds of a rate cut in June
• Stock market starts the second quarter on a back foot

Nonfarm payrolls in the spotlight this week

The focal point of the week in financial markets centres around the forthcoming release of U.S. employment data, slated for Friday. The labour data holds significant sway over investor sentiment, particularly amidst prevailing optimism that the economy could achieve a soft landing. Following a stellar first quarter performance in the stock market, all eyes are on the nonfarm payroll report, which is anticipated to reveal a moderation in job creation with an expected addition of 205,000 jobs for the month of March, down from the 275,000 jobs created in February.

Federal Reserve’s stance on interest rate cuts

Increased investor confidence in the likelihood of a soft landing scenario were boosted after the Fed at its March meeting reiterated its view of three rate cuts this year, while upgrading its outlook for economic growth. According to the CME FedWatch tool markets are now pricing in 56% chance of the Fed cutting rates in June with traders expecting a total of 75 basis points of rate cuts this year.

PCE data in line with expectations

Last Friday the Commerce Department report revealed the annual rate of Personal Consumption Expenditure (PCE) index slightly increased to 2.5% in February from 2.4% in January, in line with estimates. Meanwhile, the annual rate of growth of the core PCE index, which exclude the volatile food and energy items, slowed to 2.8% in February from an upwardly revised 2.9% in January. The report raised concerns about whether inflation is slowing quickly enough to guarantee the expected interest rate cuts signalled by the Federal Reserve.

Can the rally extend into the second quarter

The S&P 500 had risen more than 10% in the first quarter, boosted by optimism over artificial intelligence stocks and expectations of rate cuts in the second half of the year. With the commencement of the second quarter, the trajectory of the stock market is likely to continue to hinge on the Federal Reserve’s policy trajectory and on corporate earnings, which get underway in April. Despite initial expectations of six rate cuts in 2024, market sentiment has adjusted, with only three cuts of 25 basis point each currently priced in. However, lingering uncertainties regarding the inflation outlook, raises questions about the Fed’s future interest rate decisions.

Technical analysis

The S&P 500 enjoyed a strong first quarter performance with last week’s price action reaching a fresh record high of 5,264. However, the second quarter for the stock market is off to a rocky start with the index correcting over the past two days, as last week’s inflation data reduced the odds of a rate cut in June and pushed Treasury yields higher. The index rebounded to its channel line crossing at 5,200 which is likely to act as a resistance in the short-term. The large bearish divergence between the price and the Relative Strength Index (RSI) indicator, which has formed over the past three months, shows that momentum is deteriorating and suggests the rally is vulnerable to a pull back. In our view, such potential weakness is likely to be short-lived. Over the long-term, the outlook for the S&P 500 remains bullish and levels in the range between 5,400 and 5,500 appear achievable before the end of the year.

Source: TradingView

Valuation Concerns and Market Caution

While the S&P 500 continues to hover near record highs, concerns over stretched valuations persist, with forward earnings multiples exceeding historical averages. Therefore, from a fundamental standpoint a correction may be imminent before we see signs that earnings growth could be sustained to justify valuations. While this doesn’t necessarily mean the rally from the October 2022 low is nearing its end, high valuations typically lead to weaker returns in the months ahead.

Continued Monitoring of Economic Indicators

Inflation and labour market reports are the key data that will continue to shape market expectations ahead of the Fed’s upcoming meeting in June. Despite a broad-based rally in the first quarter, characterized by increased participation from industrials, financials, energy, communication services, and information technology sectors, investors would be looking for further signs the market rally is sustainable.