The Federal Reserve will address two apparent questions at its meeting this week: Policymakers’ predilection toward further interest rate increases will cease. What is the projected extent of the rate reductions in 2024? However, the Federal Reserve may also offer a response to a third inquiry that eludes the majority of investors but has the potential to significantly impact the performance of the S&P 500 and 10-year Treasury yield.
Odds of a Federal Reserve Rate Cut
The Fed exposes its cards every three months, detailing how it anticipates policy to evolve in response to incoming data. Previously, investors displayed their credentials. The markets are pricing a 2% chance that a rate increase will occur on Wednesday or at the subsequent policy update on January 31. The markets had previously anticipated a March rate reduction, but now believe it is more probable that the first of four rate cuts anticipated to be of a quarter-point each will occur at the Federal Reserve meeting on May 1.
The assessment of the implications of the Fed’s meeting statement and new quarterly projections is heavily reliant on investor expectations. The significant improvement in financial conditions that has been ongoing since late October has contributed to the S&P 500’s substantial ascent to a 52-week high, despite the precipitous decline in Treasury yields. In November, the Goldman Sachs financial conditions index experienced a decline of approximately one-half point, equivalent in impact to rate reductions of nearly one-half point.
Early in December, the University of Michigan consumer sentiment index surged 13% to its highest level in five months, as petroleum prices eased and stocks rallied. This demonstrates the Federal Reserve’s continued vigilance in order to prevent a complete resurgence of inflation and consumption. The Federal Reserve will likely be reluctant to extend further support for an uptrend in the S&P 500 and bond market, as doing so would enhance the wealth effect and reduce borrowing expenses.
Will the Federal Reserve abandon its tightening bias?
The Fed has essentially been vacillating between taking no action and implementing one more rate rise. In light of the unexpected decline in the unemployment rate to 3.7% in Friday’s employment report, there is a possibility that the Federal Reserve will maintain its tightening bias. That would entail a repetition of the language used in recent policy statements released after Fed meetings, which stated that policymakers would continue to evaluate “the extent of additional policy firming that may be appropriate” in order to reduce inflation to 2%.
Alternately, the Fed could declare economic risks to be in equilibrium, implying that a rate cut is equally probable as a rate increase. This is the more probable outcome. The Fed has justification for adopting a neutral stance. To begin with, the market would not be significantly affected, as Wall Street has already factored in four rate cuts for 2024 and considers the likelihood of a rate increase to be virtually nonexistent.
Job and Inflation Data
Furthermore, emerging data indicates that the Federal Reserve has achieved sufficient advancements in curbing inflation and decelerating growth to cease the implementation of interest rate increases. In order to ascertain the sustainability of the disinflationary trend, policymakers require six months of stable inflation data, according to Federal Reserve Chair Jerome Powell. Between October and the end of the six-month period, both PCE inflation and core PCE inflation averaged a mere 2.5% annually.
In contrast, last Friday’s employment report for November appeared lackluster, falling short of the headline gain of 199,000 hires. For the initial time since June 2021, wage growth fell below 4%. In addition, the private sector gained only 10,000 positions not in the health care and social assistance sectors, with the return of 47,000 employees subsequent to the resolution of the strikes.
In 2024, how many rate cuts are anticipated?
Regarding rate reduction, what will the Fed’s quarterly projections indicate? The September set of projections anticipated a mere quarter-point reduction from the present level, resulting in the Federal Reserve’s key rate falling within the interval of 5% to 5.25%. Nevertheless, these forecasts were made in the midst of the United States economy’s third-quarter surge, during which GDP growth surpassed 5%. Given the current deceleration in growth and inflation, it is not unexpected that the Federal Reserve maintains the identical rate outlook for 2024 that it outlined in June. This would necessitate three quarter-point reductions in the federal funds rate, resulting in a range of 4.5 to 4.75 percent.
This policy outlook is probably acceptable to Wall Street, despite the fact that markets are pricing in a full point of rate cuts for the following year and a respectable probability (44%) of a fifth reduction, which is also a quarter-point. The message would be that the Federal Reserve will be vigilant in addressing indications of economic weakness and is not unduly concerned about a resurgence in inflation.
