After holding interest rates at 5.25 percent to 5.50 percent over the last two rate cycles, on December 14 the Federal Reserve (the Fed) announced a third consecutive rate hold. While this news was broadly expected, the updated forecast for rates in 2024 was more of a surprise. The forecast showed three rate declines in the 2024 outlook.
This led many to believe that the long-awaited Fed pivot — the end of the rate-rising cycle and beginning of a rate-cutting cycle — was here. Interestingly, the Fed’s statement and Chair Jerome Powell’s testimony to Congress both stated that inflation is not at a level that the Fed is comfortable with, and projections show they don’t expect inflation to be down to the targeted levels until 2026.
So why the expectation of this being the pivot?
Primarily, we believe because the Federal Open Market Committee (FOMC) dot plot (members’ expectation for future fed funds rates) now shows the median estimate for yields by the end of 2024 declining by as much as 50 basis points. In addition, Chair Powell’s comments during the press conference after the FOMC meeting were largely interpreted to be much more dovish. He spoke about the FOMC having confidence that the economy has slowed but is healthy, as noted by the job numbers, and that, while inflation is not at the exact level, they believe the progress has been real.
But, Chair Powell warned that things can change, and the Fed is ready to respond if it does. However, these warnings are being disregarded; the market response was substantial; and stock markets surged. The equity rally was broad based, with small cap stocks up over 4 percent on the day (month to date, the Russell 2000 is up 7.7 percent) and more than double the 3.1 percent return for the S&P 500® return month to date.
Interest rates also reacted with a particular bullish drop in rates on the longer-maturity end of the market. The following graph shows the most recent peak in rates (October 2023) versus interest rates after the Fed decision. Month to date, the 30-year bond has returned 5.6 percent.
Treasury Yield Curve
Source: U.S. Department of the Treasury
What other developed countries are doing about interest rates
Last week, we also heard from the Bank of England and then the European Central Bank on their rate outlooks and, while both held rates steady, the tone from each was not constructive and differed from the U.S. outlook. This dichotomy on interest rate outlook will have longer-term ramifications for the markets, if yields are higher outside the U.S. and the dollar declines, but in the near term, U.S. exceptionalism is alive and well.
A complete pivot by the Fed is not likely just yet
While the continued health of the U.S. economy and the ongoing declines in inflation are apparent, caution is advisable because we are not out of the woods yet. In the words of the Federal Reserve:
The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals…. including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international conditions.
While we like holiday gifts as much as the next person, we believe the pivot is not yet complete.
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