Over the past 2 months, speculation
ramped up quickly regarding the pace and magnitude of Fed rate cuts in
2024. Next week brings the first Fed meeting that's in the realm of that
speculation.
Some pundits went so far as to mention
a chance of a rate cut as early as the January meeting. Could that
happen and what would the implications be of rate cuts in general?
First off, the market doesn't really
believe this will happen. There were a few days where some of the
trades in Fed Funds Futures suggested an outside possibility of a January
rate cut, but that has since been priced out of the market.
There has certainly been a shift in the
market's assessment of the Fed's stance. It took place with strong
momentum in November and December. The Fed itself added to the momentum
with the rate-friendly announcement on December 13th.
Since then, however, we have not seen
the sort of economic data necessary to fulfill the conditions of a Fed
rate cut cycle. This isn't to say it can't happen in 2024--only
that it's too soon to debate. At the very least, we know we haven't
met those conditions yet.
But what about core inflation returning
to 2%? After all, that's the Fed target and this week's GDP data
did show core PCE at 2% quarter-over-quarter.
This is not an optical illusion, but
it's important to understand the 2% inflation target is an annual
metric. The chart above shows lots of promise based on Q4 of
2023. Now we need to make sure 2% inflation sticks around so the
annual chart can align with the quarterly chart.
While it's no longer necessarily a top
priority, the Fed would also not mind seeing some more slack in the labor
market and some other signs of economic weakness to bolster the case for
further disinflation. If the economy is too strong, they need to
wonder if inflation might pick back up.
To that end, next week's jobs report
will be a big potential source of volatility, as always, but even before
then, there are several other pieces of data that could cause volatility.
Only two of them will come out before Wednesday's Fed announcement: Job
Openings (via JOLTS) and the Employment Cost Index. Of the two,
it's really only JOLTS that has a strong track record of moving markets
recently.
That leaves us to wonder how much of an
impact the Fed can really have. There haven't been any major
changes in the data since their last meeting and there is no dot plot for
each member to adjust their rate projections at this meeting. As such,
the market may come away with just as much indecision as it has endured
in the past few weeks.
Fortunately, for interest rates, this
period of correction and indecision hasn't erased the bulk of the
improvement seen at the end of 2023. Instead, it's been a token
correction, and a logical place to level off as traders wait for data
that would endorse additional improvement (or motivate a deeper
correction toward higher rates).
One place we don't have to worry about
things looking "too strong" for the Fed is in the home sales
data. This week's release of December's pending sales was quite a
bit higher than November's (nice!), but still near long term lows.
Still, this is a good proof of concept
regarding the ability of lower interest rates to motivate additional
volume. Moreover, opportunity continues to exist for new
construction, also released this week. While new home sales
declined a bit, they remain in much better shape relative to their long
term range.
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