Market resilience amid dovish Fed; inflation concerns linger

Fed meeting highlights

Last week, the FOMC voted to hold the fed funds rate steady at 5.25–5.50% for the third consecutive time. Although this came as no surprise to the market, Chairman Powell’s comments alongside an updated dot plot — both interpreted as dovish — set a Wall Street rally in motion. All three leading U.S. stock indexes advanced gains through the end of the week. Treasury yields plummeted with the two-year and the 10-year dropping to 4.25% and 3.95%, respectively. Since then, the two-year rebounded to 4.40%, however, the 10-year continued its fall, dipping under 3.90% this morning. Just two months ago, the 10-year crossed the 5.00% mark, a 100+ bps difference from today. The dollar also weakened against major currencies, while many commodities such as gold and oil climbed to weekly highs.

Powell plays Santa

At his press conference, Powell highlighted the progress made on the Fed’s dual mandate objective—maximum employment and stable prices. He stated, “Inflation has eased from its highs, and this has come without a significant increase in unemployment. That is very good news.” This has been a similar message conveyed over the past few meetings. However, the market reacted to Powell’s comments that the Fed is likely at or near its peak for this tightening cycle, which hasn’t been mentioned previously. The market is anticipating that rate cuts will occur as early as March and by the end of 2024, the fed funds rate will be hovering 3.75%-4.00%.

Curiously, the market’s reaction to the Fed’s data and comments outweighed the Fed’s own prediction for rates. For example, prior to the FOMC, the market had already priced in roughly 100 bps of cuts in 2024. The Fed’s Summary of Economic Projections release, meanwhile, introduced an average prediction of three 25 bps cuts in 2024. Still, the market expanded its expectation of cuts to price in as many as six 25-basis-point cuts in 2024.

The data plays the Grinch

To caveat the positive market sentiment, Powell said that inflation was still far too high. The Fed has been adamant about getting year-over-year inflation to 2.00%. Earlier in the week, we received fresh inflation data, which revealed that inflation slightly cooled in November. Headline CPI data slowed to 3.10% year-over-year, and the Fed’s preferred inflation metric, core CPI, which excludes volatile food and energy, remained at 4.00%. The primary driver of stickier core CPI showed to be shelter, which increased 0.40%. Elevated shelter prices could make it difficult to get inflation down to the Fed’s target. Additionally, the U.S. economy remains resilient. U.S. retail sales beat expectations, increasing 0.30% in November as consumers are still spending despite high rates. And although we are seeing a tighter job market, 199,000 U.S. jobs were added in November, exceeding expectations of 180,000.

At the conference, Powell kept the door open for more interest-rate hikes, and a continued trend of positive data could make that case. It will be very interesting to see what the Fed will do at the next meeting in late January. If this year is any indication, nothing is certain.

Looking ahead

To round out the end of the year, we get GDP growth rate quarter-over-quarter on Thursday and core PCE, durable goods, personal income, and personal spending on Friday.