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The Federal Reserve, as anticipated, maintained its current interest rates but indicated a dovish turning point that hints its subsequent action could involve a series of rate cuts in 2024. In the ” dove feast” column, the dot plot, reflecting policymakers’ projections, suggested 75 basis points in cuts throughout 2024, catching the markets completely flatfooted where most had interpolated 50 basis of cuts ( at most) and a hawkish pushback on easing financial conditions.
Federal Reserve policymakers opted to maintain their target rate range, a move widely anticipated. The surprising elements of the Federal Reserve’s recent actions were twofold. Firstly, they explicitly acknowledged the substantial decline in inflation in their official statement. Secondly, their updated projections indicated an expectation to implement a significant 0.75 percentage point rate cut in the upcoming year.
This unexpected shift resonated harmoniously with investors as the “rallying cry ” was heard from every corner of Global Financial Markets. The Santa rally shifted into high gear in off-to-the-races fashion as Treasury yields bound towards 4 %, and equities surged as the S&P 500 and Nasdaq saw a robust 1.4% rally.
Anticipations before the meeting leaned toward a more cautious approach by the Fed. However, recent economic indicators, particularly Tuesday’s inflation report from the Labor Department and a subsequent report on wholesale prices on Wednesday, likely influenced the central bank’s decision-making. These reports suggest that the Commerce Department’s preferred inflation measure, PCE inflation, is poised to reveal a notably subdued inflation scenario for November.
One could argue that the recent softer data and consistent downtrend in inflation support the case that we have transitioned into a new macro regime, and the Fed is willing to comply.
Governor Chris Waller’s perspective on inflation may be more widely endorsed than some economists perceived by the board. He highlighted the possibility of initiating a reduction in the policy rate if inflation continues to subside over several months. Waller suggested that waiting for a recession is not a prerequisite for cutting interest rates; instead, a proactive response to lower inflation could be warranted. This viewpoint implies a willingness to act preemptively to address economic conditions, even before the onset of a recession.
Compelling arguments suggest that high interest rates may now be counterproductive. Elevated mortgage rates, for instance, contribute to new records for home prices by artificially limiting resale supply. Additionally, money market funds generate over $20 billion monthly in income, essentially providing free money. It’s plausible that this extra interest income contributes more to incremental spending than any stock market rally.
While there is no certainty that the positive developments in inflation will persist, the likelihood of the Federal Reserve successfully orchestrating a soft landing for the economy appears to be on a favourable glide path.
I find it reasonable to suggest that core price growth may return to near-target levels within the next two years. The fundamental uncertainty lies in whether it will remain at that level. There’s a broader question about whether we’ve entered an era of heightened macro volatility that challenges the already questionable notion that economic outcomes can be meticulously managed around a target level by a panel of Federal Reserve Economists.
Oil markets
Oil staged a recovery rally during the New York afternoon session, propelled by a swift decline of the U.S. dollar. This shift occurred following the Federal Open Market Committee’s final policy meeting in 2023, which provided a clear signal toward easing monetary policy in the upcoming year. This development significantly reduced the likelihood of an economic slowdown in 2024 that could adversely impact demand.
Prices received an early session bid from the weekly inventory report released by the Energy Information Administration. The report disclosed a more substantial-than-anticipated reduction in U.S. commercial crude oil inventories. But providing a less bullish inference, a minor increase in gasoline supplies was attributed to an unexpected reduction in run rates by refiners.
Forex markets
In the foreign exchange realm, the primary market debate revolved around whether the Federal Open Market Committee (FOMC) would enact a policy adjustment if economic growth slows to a trend-like pace and inflation inches closer to the target over a sustained period. The Fed seems to have responded to this debate by projecting 75 basis points of “insurance cuts” for the upcoming year. This forcast is anticipated to hurt the Dollar over the short term, offering relief to more rates-sensitive G10 currencies and providing an additional boost for emerging market (EM) carry,
In light of additional evidence indicating a cooling of inflation, it is noteworthy that Fed officials are actively engaging in this discussion, further underscoring the topic’s significance in the current economic landscape.
However, the apparent Fed pivot will also open the door to rate cuts across G10 and make it less likely the BoJ needs to pivot anytime soon. So, while the dollar bears celebrate today, let’s see how they feel after the full complement of the big 3 ( FED-ECB-BOE) have their say this week.
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