Weekly Review & Outlook: December 18, 2023

The Fed delivered the dovish message for markets to extend rallies in equities and Treasuries. With limited macro news between now and year end, my expectation is for markets to settle in as trading volumes lessen prior to 2024 strategies taking a firmer hold.

The Federal Open Market Committee (FOMC) policy decision (December 13) held the target rate unchanged for the 3rd consecutive meeting and less ambiguously announced the current hiking cycle’s terminal rate was achieved. Chairman Jay Powell stated, “we added the word ‘any’ as an acknowledgement that we believe that we are likely at or near the peak rate for this cycle.” Leaving the target rate unchanged was widely anticipated. As I suggested last week, my greater area of interest is the updated dot plot for median year end 2024 Fed Funds.

The FOMC dovishly lowered its median target rate projection for year end 2024 to 4.6% from 5.1% implying a ¾ point reduction in the target rate through the year from today. Powell described one path for the projected rate cuts as “just a sign that the economy is normalizing and doesn’t need the tight policy.” The policy statement and press conference was broadly characterized by sentiment that the “expectations for inflation this year, both headline and core, have come down really significantly…growth is slowing as appropriate, and we’ve had several labor market reports which suggest significant progress toward greater balance.”

With the FOMC more inclined towards rate cuts than hikes, I expect market participants to spend greater energy assessing economic growth and maximum employment elements of the Fed’s mandate. With the broader equity markets higher by more than 20% this year, there is very little recession risks discount in prices in my assessment.

My opinion is that this sanguine view on the economic outlook may be too optimistic. S&P Global released their December Flash PMI surveys (December 15) showing tepid overall expansion due to Service sector upswing while Manufacturing posted data indicating accelerating contraction. The report commented, “Manufacturing meanwhile remains a drag on the economy, with an increased rate of order book decline prompting factories to reduce production, cut back on headcounts and scale back their input buying.” Manufacturing PMIs have not shown material expansion since September 2022.

Other forward economic signals such as the Leading Economic Index and significantly inverted yield curve continue to show elevated recession risks. The degree to which ongoing fiscal stimulus is contributing to resilient economic activity and labor markets is too frequently absent from soft landing discussions. With US debt projected to top $34T before the year end and Debt to GDP topping 122%, deficit federal spending is on course to be addressed next year despite Washington’s consensus desire to continue with today’s spending levels as the baseline. Maybe a Moody’s ratings downgrade of U.S. debt in early 2024 will help bring the issue forward while also bringing some risks discount back into prices?Merry Christmas & Happy Holidays! Weekly Review & Outlook will return January 2