Federal Reserve
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Stocks May Retreat Even as the Fed Endorses Rate Cut Bets: FOMC Preview

By:Ilya Spivak

Why stocks may turn lower as the Federal Reserve inches closer to interest rate cuts

  • All eyes on the Federal Reserve for the final FOMC policy meeting of 2023.
  • Officials may aim to signal rate cuts without endorsing ultra-dovish excess.
  • Markets in corrective mode may deflate stocks and bonds, lift U.S. dollar.

Financial markets have been consumed with speculation about Federal Reserve monetary policy since the global economy emerged from the COVID-19 pandemic with inflation rates unseen in half a century.

As 2023 draws to a close, markets are preparing to turn the page on one chapter in this story and begin another.

At its last meeting of the year, the U.S. central bank’s policy-setting Federal Open Market Committee (FOMC) looks set to bookend the blistering interest rate hike cycle that it began to signal in June 2021 and execute in March 2022. The markets are convinced that rates will remain unchanged, with a round of cuts to follow in 2024.

Fed rate cuts: how soon, and how much?

The main questions are when the cuts will begin, and how many of them are on the menu. As it stands, the first 25-basis-point (bps) reduction is priced in to appear no later than May. Four such moves are already reflected in markets, along with 47% probability of a fifth. That implies a rate reduction of 1.00-1.25% next year.

U.S. market-implied policy rates
Data source: Bloomberg

How markets react to the Fed meeting’s outcome depends on whether it forces revisions to this view. Updated economic and interest rate forecasts as well as a press conference with Fed Chair Jerome Powell are in focus. Officials deftly shaped policy outcomes through these channels without overtly adjusting rates in September and November.

November saw a sharp dovish shift in monetary policy expectations. The markets have seemingly learned to look through policymakers’ familiar well-rehearsed disclaimers about ensuring that inflation is contained and their readiness to hike rates if need be. Instead, they’ve focused on incremental dovish tweaks in Fed guidance.

The FOMC two-step: stocks at risk, dollar may rise

The current situation looks encouraging for Powell and his colleagues. Last month’s decline in expected interest rates was accompanied by falling inflation expectations priced into the bond and swap markets. This suggests the markets have been convinced that disinflation will continue even as the Fed pivots to addressing slowing economic growth.

Inflation expectations vs. Fed policy outlook
Data source: Bloomberg

Opting against any dovish signaling may push markets to see November’s moves as overdone. That could see Treasury yields and the U.S. dollar jump move sharply, amounting to an unwelcome tightening of financial conditions. Sounding too eager to cut would have the opposite effect and risk unhinging inflation expectations anew.

Finding the middle ground may be a two-pronged affair. That might mean removing the explicit tightening bias from the policy statement and tinkering with the forecasts to envision lower inflation and a higher jobless rate next year, then sending a hawkish-sounding Powell to the press conference.

Getting this two-step right may amount to a “buy the rumor, sell the fact” response from the markets. If November was the “buy” part of investors’ reckoning with the Fed’s turn to easing, this FOMC meeting may trigger the “sell” part. That could bring stocks, bonds and gold prices lower as yields and the dollar correct higher, if only in the near term.

Key markets in November 2023
Data source: Bloomberg

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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