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  • Fed Expectations Moving Around a Lot

    Torsten Sløk

    Apollo Chief Economist

    Fed expectations have been on a roller coaster ride over the past 12 months, going from six cuts to two cuts to six cuts and now 1.5 cuts, see chart below.

    Fed expectations have been on a roller coaster ride
    Source: Bloomberg, Apollo Chief Economist

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  • Removing the business cycle from the government budget balance shows that the US currently has a much bigger cyclically adjusted budget deficit than the Euro area, see chart below. In other words, despite the strong economy, the US is still running a significant deficit.

    If the US were to enter a recession, tax revenues would decline, and unemployment benefit payments would rise. Under that scenario, it is not unreasonable to assume that the budget deficit could reach 10% of GDP, as it did during previous recessions.

    Cyclically adjusted deficit is much bigger in the US than in Europe
    Source: IMF Fiscal Monitor, Apollo Chief Economist

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  • Data from downtowns shows that cellphone activity in San Francisco is at 57% of pre-pandemic levels, see chart below. Las Vegas is at 97%, and Miami is at 82% of 2019 levels. The slow recovery of downtowns combined with rates higher for longer has important implications for retail, restaurants, and offices.

    Cellphone data shows that downtown activity is still significantly below 2019 levels
    Source: University of Toronto, Downtown Recovery, Apollo Chief Economist. Note: The recovery metrics on this website are based on a sample of location-based mobility data derived from cellphones. Metrics are computed by counting the number of unique visitors in a city’s downtown area in the specified time period, and then dividing it by the standardized number of unique visitors during the equivalent time period in 2019.

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  • Japan owns $1.2 trillion of US Treasuries, and with 10-year interest rates on JGBs rising above 1% for the first time in more than a decade, Japanese investors will begin to find their own yen-denominated bonds relatively more attractive compared with US rates.

    Put differently, as Japanese yields move higher, the global savings glut will shrink, putting upward pressure on the US term premium, see also Bernanke’s speech from March 2013 discussing this dynamic.

    Any decline in USDJPY driven by such Japanese repatriation could be magnified once the Fed begins to cut interest rates. Then USDJPY would move lower not only because of higher long rates in Japan but also because of lower short rates in the US.

    The bottom line is that rising long-term interest rates in Japan put upward pressure on long-term US Treasury yields, steepen the US yield curve, and put downward pressure on USDJPY.

    For more, see also our chart book looking at Japanese demand for US Treasuries available here.

    Japanese 10-year yield
    Source: Bloomberg, Apollo Chief Economist
    When Japanese 10-year interest rates move up then USDJPY moves down
    Source: Bloomberg, Apollo Chief Economist
    Japan owns $1.2 trillion in US Treasuries. China owns $770 billion.
    Source: Bloomberg, Apollo Chief Economist

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  • A Puzzle in Markets

    Torsten Sløk

    Apollo Chief Economist

    There is a puzzle in financial markets at the moment. How can the amount of money in money market accounts go up while the stock market goes up at the same time?

    The finance textbook would have predicted that the Fed raising interest rates should increase the amount of money in money market funds and put downward pressure on equities and credit.

    Maybe the answer is foreigners, who are aggressively buying risky assets such as credit because of higher yields and a better US economic outlook relative to the outlook for Europe, Japan, China, and EM. These portfolio flows would also put upward pressure on the US dollar.

    Another explanation is that the AI story is boosting equities and credit no matter what interest rates are on money market accounts.

    The bottom line is that there is still a lot of money on the sidelines, with $6 trillion in money market funds that can be used to purchase public and private credit and public and private equity.

    There is a record-high $6 trillion on the sidelines in money market funds
    Source: Bloomberg, Apollo Chief Economist

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  • Quantifying Fed Sentiment

    Torsten Sløk

    Apollo Chief Economist

    The Bloomberg natural language processing model analyzes Fed speeches and currently shows FOMC members moving toward a tightening bias, see chart below.

    Note how the model never predicted rate cuts in 2024. Instead, Fed sentiment has simply been less hawkish in 2024 than in 2022 and 2023.

    The bottom line is that this Fed sentiment model using data back to 2009 shows that Fed communication continues to favor Fed hikes rather than Fed cuts.

    The Bloomberg natural language Fedspeak model shows Fedspeak turning more hawkish recently
    Source: Bloomberg, Apollo Chief Economist. Note: Fedspeak: NLP model of Fed sentiment. The index is underpinned by an NLP algorithm trained on Bloomberg News headlines, covering about 6,200 speaking engagements by Fed officials since 2009. A reading below zero implies rate cuts, while above zero indicates a tightening basis.

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  • The Fed Cut Reflexivity Paradox

    Torsten Sløk

    Apollo Chief Economist

    Financial conditions are significantly easier than when the Fed started raising interest rates in March 2022, see chart below.

    The strength in the stock market is partly driven by strong earnings, including from NVIDIA. But the stock market is being boosted by more than strong earnings and the prospects of AI lifting future GDP growth.

    Since the Fed pivot in November 2023, when the FOMC started talking about cuts instead of hikes, the S&P 500 market cap is up $9 trillion. For comparison, consumer spending in 2023 was $19 trillion. In other words, in a few months, the household sector has experienced a windfall gain corresponding to about 50% of last year’s consumer spending!

    Combined with continued easy fiscal policy via the Chips Act, the Inflation Reduction Act, and the Infrastructure Act, it is not surprising that employment growth and inflation have been reaccelerating in 2024.

    In short, why is the economy still so strong? Because fiscal policy is still a significant tailwind to the economy, and easy financial conditions have been offsetting Fed hikes.

    Looking ahead, with the stock market hitting fresh all-time highs and fiscal policy still supportive, the expectation in markets should be that the economy will continue to accelerate over the coming quarters.

    You can call this the Fed Cut Reflexivity Paradox: The more the Fed insists that the next move in interest rates is a cut, the more financial conditions will ease, making it more difficult for the Fed to cut.

    Financial conditions are significantly easier than when the Fed started tightening in March 2022
    Source: Bloomberg, Apollo Chief Economist

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  • This Economy Is Not Slowing Down

    Torsten Sløk

    Apollo Chief Economist

    Earnings growth is a three-quarter leading indicator for capex spending, and the continued strength in earnings suggests that we will see a strong rebound in business fixed investment over the coming quarters, see chart below.

    Continued strong earnings growth points to higher capex spending ahead
    Source: BEA, S&P, Haver Analytics, Apollo Chief Economist

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  • At the beginning of the year, the market was pricing six Fed cuts this year, six ECB cuts, and five BoE cuts, see chart below.

    Today, the market is pricing two-and-a-half cuts by the ECB and the BoC, one-and-a-half cuts by the Fed and the BoE, and only half a cut by the RBA.

    With inflation still a problem and continued strong tailwinds to the US economy from easy financial conditions and expansive fiscal policy, we continue to expect zero Fed cuts this year.

    Market is expecting fewer rate cuts
    Source: Bloomberg, Apollo Chief Economist

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  • Foreigners Prefer Higher All-in Yields

    Torsten Sløk

    Apollo Chief Economist

    Net foreign purchases of US credit have increased dramatically since the Fed started raising yield levels, see chart below.

    Foreigners have been buying more US credit after the Fed started lifting yield levels
    Source: US Treasury, Haver Analytics, Apollo Chief Economist

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