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FOMC Preview: Stock Rally at Risk as the Fed Talks Up Strong Economy

By:Ilya Spivak

Prices may tumble if interest rate cut expectations continue to fall as the Federal Reserve flags U.S. economic strength

  • All eyes are on the first FOMC monetary policy meeting of 2024 as rate cuts loom.
  • Stocks markets have roared higher so far this year despite cooling stimulus bets.
  • Fed citing economic strength may cool risk appetite as scope for easing narrows.

It has begun.

Financial markets are geared up for the first Federal Reserve monetary policy announcement of 2024, a year expected to be defined by a swift round of interest rate cuts. As it stands, traders have priced in 119 basis points (bps) in easing through December, amounting to four 25 bps reductions and a 95% probability of a fifth one.

No changes are expected at this week’s conclave. The markets put the probability of no change in the target Fed Funds rate at a commanding 97.9%. The first cut is priced in for May. The likelihood of an earlier move at the March meeting is penciled in at 42%. That’s down from 83% just two weeks ago and 100% at the end of December.

Stocks soar despite cooling Fed rate cut expectations

Pushing back the expected start date of the easing cycle lines up with a scaling down of its anticipated scope. Six 25bps rate cuts were fully priced in as recently as Jan. 12. Wall Street has managed to hold up impressively well despite the adjustment to a lower total, with the bellwether S&P 500 index hitting a record high.

Futures-implied FOMC outlook vs. S&P 500
Source: CME

That is an eye-catching change from price dynamics seen through most of the second half of 2023. Broadly, stocks trended lower in the third quarter amid an adjustment to fewer rate cuts in the 2024 outlook. Reversing in a dovish direction on the priced-in policy path marked a blistering Wall Street rally in the fourth quarter.

The critical question now is whether this “new normal” is sustainable. Divining an answer from the guidance on offer in the Federal Open Market Committee (FOMC) policy statement as well as the post-meeting press conference with Fed Chair Jerome Powell is set to preoccupy investors and define performance across financial markets.

Fed guidance vs. markets: good news is bad news?

Fed officials have insisted on being “data dependent” as the central bank tries to smooth over the transition from raising rates to cutting them. The trend there has proved to be rosier than expected. Analytics from Citigroup show U.S. economic data has increasingly outperformed relative to baseline forecasts.

Citi U.S. economic surprise index
Source: Citigroup

Last week brought the releases of impressively outsized purchasing managers’ index (PMI) and gross domestic product (GDP) numbers. So far this week, the job openings and labor turnover survey (JOLTS) revealed job vacancies unexpectedly jumped to 9.026 million in December to mark a three-month high. January’s much-anticipated payrolls report is due Friday.

This seems to demand at least some acknowledgement from policymakers, which may be interpreted as pushing back on traders’ dovish mythmaking. In December, the FOMC guesstimated that rates will be cut three times in 2024. Stocks may turn lower as the U.S. dollar gains the markets are forced to reprice closer to this more modest tally.

Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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