There is basically zero chance the Fed hikes (or cuts) rates today, so that makes this the key question for today’s FOMC decision: How much will the Fed endorse or refute the idea of rate cuts in early 2024? The answer to that question will determine if the FOMC decision helps stocks rally into year-end or give back some of the November gains.
As we and others have covered, much of the late October/November rally has been driven by falling Treasury yields as investors price in a lot of Fed rate cuts in 2024. Importantly, that expectation for a dovish Fed and rate cuts comes despite 1) The Fed directly pushing back on the idea of near-term rate cuts and 2) Economic data that doesn’t yet support cuts, meaning inflation is still too high and growth is still too strong.
So, today’s meeting is an opportunity for Fed Chair Powell to either 1) Forcefully push back on the expectation for rate cuts or 2) Not, and in ignoring that opportunity, tacitly endorse the market’s expectation for rate cuts in early 2024. Importantly, I want to make sure we understand just how big the gap is between what the Fed says will happen with rates and what the market expects.
To keep things simple, the Fed is telling us there will be two rate cuts next year. The market is expecting a minimum of four and possibly six or seven. This matters because how much the Fed “moves” towards the market expectations via the statement and dot projections will determine if the FOMC decision is positive or negative for stocks. Looking specifically at what parts of today’s FOMC decision are important, there are two keys to focus on: 1) Forward guidance and 2) The 2024 median dot.
Forward guidance remains the most important part of the statement and this sentence, found in the third paragraph of the statement “In determining the extent of additional policy firming that may be appropriate...” is key. If that sentence isn’t changed, it’s the Fed’s way of telling us rate cuts are not on the table (hawkish). If they do change it, that implies rate cuts are on the table going forward (dovish).
Turning to the 2024 median fed funds dot, In September that dot was 5.125%, meaning the Fed expected two rate cuts next year. However, that expectation also assumed an additional rate hike this year that didn’t happen. So, for today’s FOMC decision, the market expectation is for a 2024 median of 4.875%, which reflects the same two rate cuts forecasted in September but just from a lower rate (5.375% vs. 5.625%).
With that context, our “What’s Expected, Hawkish If, Dovish If” preview is below. What’s Expected: No Change to Forward Guidance and a 2024 Median Dot of 4.875%. Markets expect the Fed to partially push back against the current rate cut expectations and as such they will not change forward guidance in the statement. However, the market does expect the 2024 dot to decline to reflect two rate cuts from the current fed funds rate (to 4.875%). Likely Market Reaction: As long as Powell isn’t too hawkish during the press conference, this outcome would likely spur a modest rally in stocks and could key a rally into year-end.
To be clear, this outcome wouldn’t introduce anything new but it would remove the risk of a hawkish surprise and allow momentum to carry stocks higher into the end of the year. Stocks should see a modest to moderate rally and we’d expect continued broadening of the rally with cyclicals and “dividend proxy” sectors (utilities and REITs) rallying off a decline in yields and expectations for a resilient economy.
Looking at this from a commonsense point of view, I don’t believe the Fed will lower rates at all next year unless the economy begins slowing too much. As such, despite my argument about market perceptions, I believe this market will move with positive data on earnings each quarter. If the Fed lowers interest rates, the markets will respond positively but the market upturn is not dependent on interest rates.
The bottom line is that those who think the Fed can just manage its way out this easily, cutting rates to offset the pain of recession (or avoid one entirely), may not be correct. Many seem to have submitted to “state-run capitalism.” But history shows it has never really worked. The Fed is likely to “do nothing” this week and holding that position in 2024 might not be a bad thing.
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