This week will feature several key economic data releases. The schedule begins on Monday with the ISM Manufacturing report, followed by the JOLTS report on Tuesday, ADP and ISM Services on Wednesday, an ECB meeting on Thursday, and the jobs report on Friday. Additionally, intermittent trade news could also impact the markets.
Current expectations indicate a relatively healthy economic outlook. The ISM reports are anticipated to show a slight improvement in business activity for May, while the jobs report is expected to reflect a continuation of the status quo. This scenario would likely mean that Fed interest rate cuts may be delayed further, potentially disappointing those who wish them sooner rather than later.
Currently, the market is pricing in only about two rate cuts in 2025. This number could easily decrease to one if this week’s data aligns with or slightly exceeds expectations.
The overall data seems to suggest that the current policy rate is not far from the appropriate terminal rate; in fact, policy might be precisely where it needs to be. Barring a recession, the Federal Reserve’s easing cycle appears to be either complete or nearly complete. It’s difficult to foresee a scenario right now that would compel the Fed to cut rates significantly further.
This outlook would argue for higher rates on the long end of the curve than are presently observed, leading to a much steeper yield curve. Currently, the spread between the 10-year Treasury rate and the Federal Funds rate seems too narrow to adequately compensate for the duration risk associated with owning a 10-year bond.
If it becomes clear that the front end of the curve (short-term rates) has limited room to fall from current levels, this will likely continue to exert upward pressure on the 10-year rate.
This is arguably the most underappreciated risk for the stock market currently: the possibility that long-end rates have further to climb, given the shallower expected path forward for monetary policy. Therefore, at least in the near term, this likely means the 10-year yield could rise to around 4.8%. This would also suggest a 30-year rate that goes to new cycle highs, well above 5.15%.
Additionally, we need to monitor credit spreads more closely. We are beginning to see signs that they may not return to the tight levels observed in 2024. The 10-year euro swap spread, which has often served as a leading indicator for overall credit spreads, is now on the cusp of turning positive again.
This would align with its historical positioning, as it has traditionally been positive.
This could be particularly important for high-yield credit spreads, even in the US, as different types of credit spreads often exhibit correlated movements over time.
This scenario could also lead to tighter liquidity and higher dollar funding costs, potentially indicated by the 5-year USD/JPY Cross-Currency Basis Swap (CCBS) spread. If this spread, when inverted as you noted, it appears in the chart you’re viewing, is widening, it would typically illustrate such tightening dollar funding conditions.”
In the meantime, complacency seems to be the prevailing sentiment in the stock market. There are at least three identifiable patterns in the S&P 500 futures that could argue for an upcoming turning point: a diamond pattern, a rising wedge, and a potential double top. Each of these would require confirmation that a bearish trend has started. For that confirmation, we would need to see the S&P 500 futures fall below 5,770.