COM - No Longer How High For The Fed But How Long

2023-10-12 09:57:21 ET

Summary

• Market gains continue as long-term bond yields decrease and Fed minutes offer a balanced outlook.
• Rate-hike debate is over, focus shifts to when the first rate cut will happen in 2024.
• Concerns over energy costs alleviated as crude oil prices decline, allowing consumers to redirect income.

The major market averages logged a fourth consecutive day of gains on the tailcoats of lower long-term bond yields and the 2pm release of minutes from the Fed’s September meeting, which offered a more balanced outlook. While most policymakers suggested that another rate hike might be necessary at that time, the consensus view was that the risk of overtightening was now balanced with the risk of not tightening enough. Several Fed officials have indicated since then that the rise in long-term bond yields has largely done the work of further tightening for the Fed, which is why the focus is no longer on how high rates will go, but how long they remain at current levels.

I believe the rate-hike debate is over, and the CME Fed funds futures market agrees, as the probability of another increase this year has fallen to just 26%. Regardless, we will probably continue to hear some Fed officials deliver speeches with a hawkish tone, but this is more about managing expectations than making policy decisions. The discussion is likely to shift to when we see the first rate cut in 2024, which I think will come sooner than the consensus expects because the Fed will reach its inflation target of 2% well before 2025.

A major concern for Fed officials cited in the meeting minutes was the sharp rise in energy costs, which some worried could pose upside risks to inflation, but crude oil (CL1:COM) has plunged nearly $12 from its recent high of $95, which should alleviate worries.

I did not see it as a reason for concern in the first place, as gasoline prices were no higher during the Fed’s meeting than they had been a year earlier. In fact, the latest weekly data from AAA shows the nationwide average has fallen to $3.66. The decline allows consumers to redirect discretionary income to other goods and services, which could not be timelier as the rate of economic growth slows under tighter financial conditions.

A soft landing is a constant tug-of-war between stronger-than-expected and softer-than-expected incoming economic data. This means bulls and bears can both point to statistics that help build their respective cases for very different economic and market outlooks. Yet in the soft-landing scenario, the economy avoids a contraction, as the stronger-than-expected data wins out. Critical to this outcome is a Fed that avoids suffocating the economy before price stability is achieved. I think it has done so, provided its next move is a policy easing during the first half of 2024.

The most encouraging sign for the economy today is the fact that Wall Street analysts are increasing their earnings forecasts for the companies they follow in the year ahead, despite much tighter financial conditions. This is not what we see on the cusp of an economic contraction or recession. While the consensus sees a return to year-over-year profit growth for the S&P 500 (SP500) in the fourth quarter, I think we will achieve that in one just ended when we conclude the third-quarter earnings season. This is why the market has started to recover its losses from August and September during the first several days of October.

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