What a difference a year makes. Today’s Fed meeting is likely to go down as one of the most pivotal of the cycle. Not just because it included a pivot in messaging from Chair Powell, but because it came on the heels of a blistering rally in stocks and bonds that blistered even further upon hearing him talk.
And perhaps deservedly so. Looking at the chart below, we can see that 2023 turned out much better than the Fed expected on all fronts: GDP growth came in higher than their forecasts, inflation and unemployment came in lower. For 2023, this is the illustration of “crisis averted”.
Although the market already believed July marked the final rate hike of the cycle, Chairman Powell all but confirmed that today, and shifted the narrative into new territory regarding when it might be appropriate to start cutting.
It was nuanced, but obvious. They continued to resist declaring victory (because inflation remains above the target of 2%), but all the market needed to hear was something that suggested we were moving away from restrictive policy, and that it got.
Seasons of Dove
Remember when we were worried they wouldn’t hike fast enough? Remember when inflation kept surprising to the upside and the dot plot kept chasing it higher and higher? Those days are gone. Now we look into 2024 and compare what the dot plot says about rates with what the market says.
Today was also pivotal because it was the first time in a long time when it seemed like the Fed bent to get closer to the market’s expectations. The larger the gap between what the Fed is saying and what the market is expecting, the more precarious the situation because it enhances the uncertainty. But today, that gap narrowed a bit and for the time being, that’s something to celebrate.
What’s interesting, however, is that the market is consistently below the Fed’s forecast of where rates will be next year. Stocks have rallied to new highs in some cases, on the expectation of lower rates, sooner cuts, and plummeting Treasury yields. The dot plot (blue) shifted to suggest more cuts in 2024 than in its last release, but it still suggests higher rates for longer than the market is pricing in (red).
Next year is going to be nothing short of fascinating, perhaps on this point alone. Will the market muscle the Fed into sooner and deeper cuts, or will Powell stand pat on “higher for longer”? It all seems to hinge on the labor market. If 2023’s theme was the year of inflation, 2024 could turn out to be the year of jobs.
Rent the Rally
It’s tough to argue with a major index hitting an all-time high (the Dow closed above 37,000 for the first time today). For the time being, the data and the Fed seem to be moving in the right direction. The important thing to remember is that it’s all still moving, and the more time that passes, the closer into view the next phase becomes. I believe we can survive the period of the pause as risk appetite stays supported by falling rates and cooling — but not freezing — data.
Next year will be a new environment, but until then, let’s enjoy the ride.
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