If I didn’t watch markets last week and was told that 1) the CPI came in hotter than expected on headline and core and 2) Fed officials, including New York Fed President Williams, pushed back on the idea of a March rate cut, I’d have expected markets to be down. Instead, despite those negatives and decidedly mixed earnings on Friday, stocks rallied and that begs this question: Do markets really care if the Fed cuts in March or not? The short answer is “no,” they don’t.
If the Fed does not signal a March rate cut, that will be a negative influence on stocks and bonds, but not a substantial one. Perhaps that results in a 3%ish pullback—nothing to ignore but not a material move in markets for anyone with a medium- or long-term time horizon (like most of us). That muted reaction will be because markets will assume that if the Fed doesn’t cut in March, it will cut in May and more importantly, the current expectation of six rate cuts in 2024 will, more or less, stay intact.
But if the Fed doesn’t signal a May rate cut either, then the market likely will care about that, a lot, because no rate cuts through May means the market is very wrong about its aggressive expectations for Fed easing. And, since a lot of rate cuts is one of the key assumptions underpinning the fourth-quarter rally, that will leave this market vulnerable to a 10% (or more) decline.
Put differently, from a market standpoint, it doesn’t matter so much when the rate cuts start, as long as the expectation for a lot of policy easing (so more than four rate cuts) remains intact. So, the real risk for this market from a Fed standpoint is that the Fed follows its own projections and only cuts twice (or three times). That’s why stocks didn’t drop last week despite the uptick in inflation and hawkish commentary. While both the hot CPI report and hawkish commentary could reduce the chances of a March rate cut, neither were viewed as bad enough to reduce the chances of numerous rate cuts in 2024, and as such, whether they begin in March or May isn’t that important in the grand scheme of things.
Practically speaking, that means that hawkish news will only be a mild negative until it gets strong enough to get markets to rethink the idea of massive policy easing (meaning four-to-six rate cuts), and that’s the lens through which we need to view the inflation data and Fed rhetoric for the next several weeks.
If the data makes a March cut unlikely, it’s just a mild negative (1%-5%). But if the data makes March and May cuts unlikely, that’s a more substantial negative (5%-10% or more). From a positioning standpoint, defensive sectors have outperformed cyclicals YTD while value has outperformed growth, and I think that can continue given a potential slowing of economic growth and potentially underwhelming earnings season.
Because of my concern about a looming growth scare, I continue to prefer lower volatility and higher-quality stock exposure. In our managed accounts we remain 30% in value/dividend stocks. In annuities and mutual funds, we continue to stay with quality.
As I have said over the past month, during an election year, expect some volatility during the primary season and move up after the election.
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