For those of you who would prefer to listen:
The Federal Reserve’s rate-hiking cycle has come to an end. At least that’s the message that was received Wednesday. The Market exploded with enthusiasm as the year-end rally continued. The magic words were rate cuts in 2024. This was a major pivot by the Fed.
The Market had already been pricing in a full 1.25% cut next year, taking the current overnight rate range of 5.25-5.5% down to 4.1%. The Fed didn’t go that far. But they did guide to 4.6% in 2024, which was a big change from their last meeting held in September. That said, Fed Chair Powell did say that another rate hike could not be ruled out. The central bank identified inflation as the reason. The Market totally ignored that. The rate of price increases has slowed, and the Fed must be thinking it is on track to meet its 2% goal.
Fed officials now anticipate making 3 rate cuts next year and 4 more in 2025, according to the Summary of Economic Projections. The unemployment rate remains low, near 50-year lows, in fact, which has gone a long way in keeping the US Economy afloat. When you have a job, you tend to spend. Americans keep spending. Chair Powell reiterated that future economic data will ultimately dictate the Fed’s decision on interest rates. The Fed Chair acknowledged that it is premature to declare victory, but this messaging gives off a strong sense of achievement at America’s central bank. A soft-landing was their goal. The Bulls see it happening and are celebrating.
What’s different, you might ask? This time, there was no pushback from Powell against the Market’s aggressive rate cut expectations. In fact, he acknowledged the Fed had already started discussions of dialing back the amount of policy restrictions. Chair Powell made it clear the Fed will not wait until inflation is back at its 2% target to start lowering rates. This was a new stance from the Fed Chair. He went from Hawk to Dove almost in an instant. Stocks soared and yields fell, taking bond prices higher too. The benchmark 10-Year Treasury yield fell below 4% for the first time since Summer. It hit 5% in October. Yields are not supposed to be that volatile. The moves have been massive, in both directions, in pretty much every asset class. That’s really been the way of the Market since Covid.
Here’s the deal: For the Fed to cut that aggressively, it would have to be in response to much slower economic growth. Quite frankly, it would come in the face of recession. As it stands, the Fed is not anticipating a recession, modeling 1.4% economic growth next year. The Fed doesn’t see recession at all ahead. There are still a number of recessionary pressures out there. Consumers have been showing signs of strain. Layoffs are on the rise. Both Citigroup and Hasbro announced them again this week. It’s happening on Wall Street and Main Street. Hasbro said demand for toys under the tree this year has slowed. Something’s got to give.
Even though Consumer spending is slowing. It’s still happening. Retail sales surprised to the upside in November, with the control group measure rising 0.4% month-over-month. It was up over 4% if you annualize it, so a very solid number. In fact, it was the highest since February. The Fed pays close attention to the control group to gauge Consumer health. Another takeaway is Americans are spending more time shopping online. That’s not a big surprise, as the irreversible trend keeps gaining momentum. Non-store sales increased 1% in November from October. Early Holiday shopping was the clear driver.
The good news is with lower yields, the cost to service the mountain of Federal debt is coming down. It’s about to hit $34 Trillion. This is a gift for Congress to once and for all agree on a plan to cut excess spending and pay down the enormous debt position. The bad news is, we aren’t even close to hopeful that this Congress does anything here.
Mortgage rates back down to 6.5%, the lowest since Spring. That certainly helps Housing. Inflation on Goods has come down substantially. Gas prices have too. But service inflation, as measured by wages and hospitality, have shown little signs of declines. TV sales rose as prices fell. Costco told us that this week. Freight costs have come down drastically. The cost to ship from Asia to California has declined by 90%! You know what hasn’t come down? Food. The price of food stayed up. You know what else was a hot seller at Costco? Gold. Costco sold $100 Million worth of Gold bars in just 3 months. Apparently, many Americans are swapping toys for Gold under the tree this year.
There’s still that Arthur Burns lesson out there that Fed Chair Powell is all too familiar with. The Market clearly cheered the Fed’s dovish pivot and is making a big bet on interest rate cuts coming much earlier than expected. But there are some words of caution. European central banks and the International Monetary Fund’s chief warned against jumping the gun in this battle against inflation. “Sometimes countries prematurely declare victory and then inflation gets more entrenched, and the fight becomes harder.” That was the IMF statement. But many believe the Fed has now set the tone, making it harder for other major central banks to remain hawkish.
Arthur Burns was Chairman of the Federal Reserve from 1970-78. He presided over a challenging time with inflation. He is best known for letting inflation run rampant. Burns was replaced by Paul Volcker, who was a giant in every way. The 6 foot 7 inch Volcker had guts. He aggressively raised interest rates, making plenty of enemies along the way. But he did what he thought was right, no matter what people thought. He made sure inflation was whipped for good. Paul Volcker was hated then. Paul Volcker is revered today. Jerome Powell wants to be the next Paul Volcker. Jerome Powell absolutely, positively does not want to be the next Arthur Burns.
Back to the Market:
The year-end rally is on. The Dow hit an all-time high in the wake of the Fed pivot. 37,000 had never been reached before. That’s where it stands today. Though the price-weighted, 30-stock index is not reflective of the total Stock Market, the significance of the move is still very real. Both the S&P 500 and Tech-heavy NASDAQ hit 52-week highs this week as well. The S&P finished higher for a 7th straight week. That’s only happened 10 times since 1990. It last occurred in 2017. Interestingly and also significant was the fact that the Tech Titans, which have dominated 2023, underperformed this week. It was the stocks that got beat up the most that led. That’s new too.
There’s nothing like price to change sentiment. That’s something that I’m always mindful of as a Market professional. The panic levels from October switched back to near euphoria as the rally grew. The number of Investor Intelligence Bulls increased to 55.6% this week. The report marked the third straight week in caution territory. This last happened in late July when the Bulls reached 57.1%. You might remember that was the previous high for the year before the 10% decline in August and September. Sentiment is always a contrarian signal on Wall Street. Investors prove time and again their emotions. They tend to get excited at Market tops and panic at lows. That’s been the way for decades.
Also influencing price action this week was record option action. Friday was a Quad Witching. That means all 4 sets of option contracts expired simultaneously. It leads to increased volatility. Friday saw over $5 Trillion in S&P 500 options expire. That was a record. That no doubt influenced the wide swings. But overall volatility has been extremely low. The volatility index, better known as the VIX, sits at 12. That is a 4-year low. It cleared 20 at the October lows. For an even better perspective, the VIX spiked to 85 during the Covid crash. The VIX measures expected volatility 30 days out. The point is, there’s a lot of complacency out there for an environment that still has so many dangerous issues.
This rally sure has felt good. Participating have been both bonds and stocks. That’s the first time it’s happened in a while. Lower yields have removed that chokehold on asset prices. This rally has certainly caught many off guard, which triggered a year-end chase. At this stage, stocks are certainly overbought and there’s a whole lot of good news already priced in. But the thing is, overbought always lasts longer than oversold. We still see this year-end strength holding in through December and perhaps spilling into January. It’s been a really fast Market. They move both ways. This has been a powerful swing upward. We’ll take it.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
