• US retail sales disappoint but Fed does not budge on its hawkish stance
• Dollar holds firm after Friday’s gains, stocks find some support from strong bank earnings
• But markets overall steady as busy data and earnings week gets underway

Recession fears are elevated after retail sales figures out of the United States on Friday pointed to slowing consumer demand in the world’s largest economy. Headline retail sales slumped by a worse-than-expected 1.0% in March compared to February. Lower gasoline prices and a drop in motor vehicle sales attributed to much of the decline, but even the closely watched core control group measure, which strips out all volatile components, fell in March.

Manufacturing production also contracted more than expected during the period, in a further warning sign of flagging growth. However, in both cases, the prior month’s numbers were revised higher, and it seems that on balance, the data were not bad enough to unnerve policymakers at the Fed.

It’s likely that consumers were more cautious in March when the banking sector came under stress and there was a deposit flight. But all the indications are that calm is being restored, not just within the banking system, but also among consumers. The University of Michigan’s consumer sentiment gauge ticked up in April’s preliminary reading. More importantly, the survey’s measure of consumers’ one-year inflation expectations jumped from 3.6% to 4.6%.

The surprise pickup in inflation expectations came after a steady decline in recent months, underscoring the need for the Fed not to take its eye off the ball. Fed Governor Christopher Waller on Friday acknowledged that the central bank hadn’t made much progress in getting inflation back to target, warning that “monetary policy needs to be tightened further”.

Atlanta Fed President Raphael Bostic struck a somewhat more moderate tone, signalling only one additional quarter-point rate hike. But this wasn’t enough to soothe the markets as Waller reiterated that policy will have to remain tight for “a substantial period of time, and longer than markets anticipate”.

Rate hike expectations for the next meeting in May tightened in the aftermath, with investors currently pricing in a more than 80% probability of a 25-bps increase. What’s more noteworthy, however, is that expectations for rate cuts have fallen by around 20 basis points after Waller’s comments, in somewhat of a reality check for the markets.

Still, whilst Wall Street ended Friday down, there were no signs of carnage in equity markets, with the S&P 500 closing just 0.2% lower. In fact, US futures are trading higher on Monday and European indices have started the week with solid gains. Banking giants Citigroup, JPMorgan Chase and Wells Fargo reported better-than-expected earnings on Friday. Smaller regional banks didn’t get off to such a strong start as PNC Financial issued disappointing guidance for 2023.

Bank of America and Goldman Sachs are due to report on Tuesday, but tech earnings will likely steal the limelight this week as Netflix’s financial results are also due tomorrow, while Tesla will publish its earnings on Wednesday.

Given that the US economy is more likely to slow further than not, it’s difficult to explain some of the valuations on Wall Street right now. Investors still seem to be putting money on financial conditions loosening at some point in the second half of this year and the danger is what would happen if the Fed sticks to its word and keeps rates high through to 2024.

At least currency traders seem to be heeding the Fed’s message as the US dollar spiked up by about 0.5% against a basket of currencies on Friday and is extending its gains today. The 10-year Treasury yield has risen to two-week highs and this could keep the greenback supported in a week where there’s a barrage of inflation data coming out of other countries, including the UK and Canada.

Sterling has fallen sharply over the last couple of days, ceding control of the $1.25 and $1.24 handles. Aside from the CPI release, pound bulls will be hoping for a boost from tomorrow’s employment figures and Friday’s flash PMIs.

The latter will also be the focal point for the euro as it slips below the crucial $1.10 level.

The stronger dollar also made a dent in gold prices, but the precious metal is rebounding today after briefly breaching $2,000/oz. The rising uncertainty about the economic outlook could be aiding gold even as Treasury yields hold near Friday’s highs.