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The Reason Stocks and Bonds Are Declining

January 18, 2024

The Reason Stocks and Bonds Are Declining (You’ve Seen It Before) Stocks declined for the second straight day this week and the reason for the drop is clear: Expectations for a March rate cut are falling and since that idea was a major contributor to the late-December melt up, we’re seeing some of those gains given back.

To that point, at the start of the year, fed funds futures were pricing in virtually a 100% chance of a March rate cut. Now, thanks to pushback from the Fed and ECB, as well as some “hot” economic data (last week’s CPI, yesterday’s retail sales, and the December jobs report), we’re seeing those expectations for a rate cut decline.

At this point, it’s about a 60% probability of a March rate cut and the drop from 100% is the reason behind this dip in stock prices. If the probability of a March rate cut falls solidly below 50%, expect the S&P 500 to continue to pull back also. These declines are largely what we’d expect, and in Tuesday’s issue, we cautioned that if the market dialed back May rate cut expectations, we could see a mild pullback in stocks. That’s what’s happening now, and it’ll continue if the probability of a March cut falls below 50%.

However, it’s going to take a May rate cut coming into doubt for Fed policy to become a real headwind on markets and open up the possibility of a 5%-10% decline in stocks. So far, there is no budging on the May rate cut expectations as they remain above 90%. However, where that number goes, stocks also will go. And if we see that May rate cut probability fall to and through 70% and 50%, expect a pullback in stocks to intensify (meaning that 5%-10% probability).

Bottom line, the market is dialing back some of its rate-cut expectations, but it’s still way ahead of the Fed. As things sit now, markets can withstand no March rate cut. But if we see those May rate cuts come into doubt then don’t be surprised if the S&P 500 trades to, and through, 4,500 or lower. For now, the markets will move up with positive earnings reports for the fourth quarter which are coming in over the next 3 weeks.

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