When Doves Fly...
The Federal Reserve meets every six weeks to decide on the path of monetary policy. During their most recent meeting, the Fed not only announced they were keeping rates unchanged, in an unexpectedly dovish fashion, they also released a new set of projections that included lowering rates by next year. This was the first time since the beginning of the current historic hiking cycle the Fed has acknowledged they are discussing rate cuts. Fed Chair Jerome Powell said that inflation was cooling faster than expected, and 17 out of 19 Fed officials now expect interest rates to be lower by the end of 2024.

Phantom Recession
Although the Fed acknowledged that price pressures are easing somewhat faster than anticipated, the pace of disinflation is still stubbornly slow. The Fed does not see inflation failing back down to its target of two percent until sometime in 2025. Remarkably, after a rapid and blistering round of more than five percentage points of rate hikes, the overall economy has remained resilient. Unemployment remains at historic lows and robust numbers of job creation have persisted despite broad consensus that the US would slip into recession in 2023. To continue avoiding an economic slowdown, the Fed may start lowering interest rates before inflation has fallen all the way back to their target.

Markets Bounce
Celebrating what seems widely viewed as confirmation of the conclusion of the Fed’s rate hiking regime, markets rose in the run up to the Fed’s decision and in the wake of their announcement. After briefly entering correction territory of ten percent below their recent highs, stocks have rebounded, bouncing by more than 15% since October. Markets have now risen by 35% from their lows in October of last year, regaining nearly all of their losses from the peak of January 2022 reached prior to the Fed embarking on their current hiking campaign.

Looking for Cuts…
While markets have seemed to cheer what may be the conclusion of an historic rate hiking cycle, investors will still need to continue adjusting their outlook for the timing of upcoming rate cuts. There is a wide gap between the amount of cuts markets are expecting next year versus what the Fed has penciled in themselves, with the Fed projecting 75 basis points of cuts in 2024 compared to market expectations of around twice that amount. Markets have continually pushed back their expectations of when cuts are coming, having initially expected them to be made by this year. At some point, market expectations will converge with the Fed’s own projections, either by markets adjusting to rates staying higher for longer than they currently expect, or by the Fed moving to cut sooner than they expect, possibly spurred by downbeat economic data or an acceleration in the fall of inflation.

December 20, 2023