FED POLICY IMPACT
Following the December FOMC meeting, it appears the Fed is done raising rates in this tightening cycle. When looking at Fed policy for 2024, the pivot for rate cuts has now come into focus.
Against that backdrop, the question is whether the Fed will provide forward guidance about cutting rates as early as the January meeting and make a move as soon as the March 2024 meeting, like the money and bond markets are expecting, as of this writing. The timing for actual rate cuts will be dependent on upcoming economic/inflation reports, with Chairman Powell, once again emphasizing the “totality” of the data.
A big concern we have is heightened volatility in the U.S. Treasury (UST) market caused by uncertainty around Fed messaging and market expectations. This scenario has played out many times. The Fed thinks the markets misinterpret it, and the disconnect has a negative effect.
We do believe the Fed made a policy mistake on the inflation front by not hiking quickly enough. The last thing it wants to do is make another error in declaring inflation dead and cutting rates prematurely. However, the policymakers appear to have now struck a balance by becoming flexible about future decisions.
The longer the Fed stays too high, the more risk there is in the whole system, for the economy and for equities. Bonds lost their typical hedge characteristics in the last 24 months when rising bond yields triggered a sell-off in equities. Bonds weren’t the insurance asset they used to be, when stocks would go down and bonds would go up. While bond volatility has experienced record highs, the trend for equities has been lower volatility. A solution for heightened volatility in the bond market could be floating rate Treasuries—and that is the best hedge for equities.
Thinking ahead to rate cuts, expectations have changed dramatically, and they will no doubt continue to evolve throughout 2024. While the Fed’s revised Dot Plot now sees three rate cuts worth 75 basis points (bps) for next year, as we went to press, the market was pricing in six cuts totaling 150 bps. The key question for 2024 is: will the Fed match the market’s newfound expectations or will the markets be disappointed? That being said, the bottom line message is that rate cuts are coming, it’s just a question of timing and magnitude.
The question is whether the Fed will provide forward guidance about cutting rates as early as the January meeting and make a move as soon as the March 2024 meeting.
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