Last week, we said, “All eyes will be trained on next week’s Fed meeting.” And while the meeting wasn’t a surprise, the commentary was definitely unexpected. It was a prominent shift from the Fed as the tone and message were quite different from previous meetings this year. Clearly, the market was not expecting the about-face either, as stocks and bonds rallied immediately following. Let’s explore the details.
All year, Chair Powell has been very cautious about not letting market participants get ahead of themselves when it comes to loosening monetary policy. He has continually said there is much work to do and that the Fed did not believe conditions were “sufficiently restrictive.” So when the Summary of Economic Projections (SEP) was released along with the meeting statement, it was surprising to see the change in direction.
There were so many dovish quotes from the chairman that it is hard to pick which ones to highlight, but we’ll emphasize a few:
- “We believe we are either at or near the peak for the cycle.”
- “It would be too late to wait for 2% CPI to reduce tightening; you want to do that well before 2%.”
- “When to start dialing in policy tightening was clearly a topic of discussion for the FOMC today.”
- “Disinflation is broad: we have made meaningful progress on all three categories we watch.”
In aggregate, these comments were nothing short of a clear signal that the dovish pivot is here.
Moving to the SEP, it was a trifecta of good news with improvements across estimated GDP, inflation, and the Fed Funds rate (see image below). Not only does the SEP show GDP to be 50 basis points higher in 2023, but that is in conjunction with inflation being 50 basis points lower and the unemployment rate staying at 3.8%. Based on what the members are anticipating, it appears they are convinced of the arrival of the mythical “soft-landing.”
Now remember, contrary to popular belief, a dovish pivot doesn’t mean the Fed is already cutting rates. Instead, it means the necessary conditions for cutting rates are close, and the monetary policy stance changes from “we fight inflation at all costs” to “inflation is going down, and we cut rates so we don’t remain ultra tight.” So, while the SEP shows three rate cuts during 2024, this is just the committee’s median expected outcome based on what they know today. They are very clear that this is NOT a forecast. With so many variables that could change in either direction, we know better than to cast this in stone.
While Chair Powell didn’t explicitly say “Merry Christmas,” he might as well have. By upgrading GDP, downgrading inflation, and downgrading the Fed Funds rate path, the FOMC has given a thumbs up to further strong performance from equity markets and validated market pricing of cuts throughout 2024.
Economy
- Markets rallied again, with the S&P 500 up 2.5%, the Nasdaq up 2.8%, and the small-cap Russell 2000 up 5.5%. It was the Fed meeting that pushed the market higher this week with a more dovish tone than expected.
- Core CPI in the U.S. stood at a more than two-year low of 4% in November, unchanged from October, matching market forecasts.
- Headline CPI in the U.S. slowed to 3.1% in November, the lowest reading in five months, from 3.2% in October, in line with market forecasts.
- Producer prices in the U.S. steadied in November, following a 0.4% fall in the previous period, compared to a 0.1% rise forecast.
- Retail sales in the U.S. unexpectedly increased 0.3% MoM in November, rebounding from an upwardly revised -0.2% fall in October, beating market forecasts of a 0.1% decline.
Stocks
- U.S. equities were in positive territory. Real Estate and Materials were the top performers, while Communication Services and Utilities lagged. Value stocks led growth stocks, and small caps beat large caps.
- International equities closed higher for the week. Emerging markets fared better than developed markets.
Bonds
- The 10-year Treasury bond yield decreased 32 basis points to 3.93% during the week.
- Global bond markets were in positive territory this week.
- Corporate bonds led for the week, followed by government bonds and high-yield bonds.
