This morning, the attention of Wall Street is clearly on the Federal Reserve’s final monetary policy decision of 2023, which was announced at 2:00 P.M. (EST) yesterday. Before we get to that market-moving news, we do want to highlight some important economic reports issued today. At 8:30 A.M. (EST), the Commerce Department reported that retail sales for the month of November rose 0.3%, which was better than the consensus forecast (-0.1%) and the previous month’s decline of 0.2%. In general, sales during the holiday shopping season have been good, highlighted by a nearly 8% year-to-year increase, to roughly $38 billion, during the four-day period ranging from Thanksgiving to Cyber Monday. So all in all, consumers appear to be spending, despite the modest decline last month. Meanwhile, jobless claims for the week ending December 9th came in at 202,000, which was down sharply from the prior week’s figure and still indicative of a tight labor market. The equity futures are indicating a resumption of yesterday’s buying when the stock market opens stateside.
As noted, the busy week’s biggest news came yesterday afternoon, with the Federal Reserve concluding its final monetary policy meeting of 2023. As expected, the Federal Open Market Committee (FOMC) held the federal funds rate in the range of 5.25% to 5.50%. It was the third-consecutive pause for the central bank, which looks to have finished its interest-rate hiking cycle. In the statement, the Fed said that inflation has eased, lowering its 2023 core Personal Consumption Expenditures (PCE) forecast by a half-point, to 3.2%. Likewise, the European Central Bank (ECN) kept its benchmark short-term interest rate steady and lowered its inflation expectations this morning.
Overall, the FOMC and the central bank struck a more dovish tone, and appeared to back away from the bias to hike rates again in the statement. The Fed seemed to be pleased that inflation, as reflected by yesterday’s report of a drop in November producer (wholesale) prices, continues to ease. The report also showed that the lead bank now expects the economy to expand by a below-trend rate of 1.4% next year. The Fed’s interest-rate dot plot, which is highly scrutinized by Wall Street to get a sense of how the central bank policymakers feel about future rates, showed an increase in the rate of cuts for next year, though the breadth will likely be highly dependent on the pace of economic growth over the next 12 months. Our forecast calls for two to three cuts in 2024, most likely in the second half of the year, though the magnitude of the reductions will probably depend on the pace of economic growth over the next 12 months. The central bank said that it could see a three-quarter-point decline in the federal funds rate next year.
The Fed’s timeline for cuts appeared to move a bit closer to Wall Street’s thinking. This, along with dovish remarks from Fed Chairman Jerome Powell, put sharp downward pressure on Treasury market yields and ignited another spate of buying in the equity market that saw the Dow Jones Industrial Average top the 37,000 mark for the first time in its history. In the up-and-down markets of 2022 and 2023, the Dow never fell as sharply as the other major indices; thus, while its 2023 YTD gain is shy of the others, it is the first index recently to hit an all-time high. The Dow, along with the NASDAQ Composite and the broader S&P 500 Index, all rose 1.4% yesterday. The yield on the benchmark 10-year Treasury note, which serves as a proxy for long-term rates, fell sharply and currently sits below 4.00% this morning. Chairman Powell stated that it would be premature to declare victory over inflation, but did say that possible interest-rate cuts are starting to come into view.
The Fed news gave a boost to the interest-rate sensitive industries, with notable gains recorded by the technology and consumer discretionary sectors. The specter of rates coming down next year also was a shot in the arm for the small-cap companies, where business decisions are predominantly based on the cost of borrowing funds. The performance of the small-cap stocks up until the start of November had lagged their larger-cap brethren for most of this year. The small-cap Russell 2000 rose an outsized 3.5% yesterday.
The Federal Reserve did say that the U.S. economy is slowing, and the probability of a recession next year still exists. However, with the labor market holding up (Mr. Powell noted that demand for labor still exceeds available workers), the likelihood of a “soft landing” remains very much in play. Our sense is that the Federal Reserve, which is pleased with the direction inflation is moving, is unlikely to raise interest rates further and cause certain areas of the economy to struggle and in a worst case scenario break.
In conclusion, the Federal Reserve and Chairman Powell’s post-decision commentary did not throw any cold water on the ongoing year-end Santa Claus rally. However, the sharp rise in equity prices since the start of November has pushed stock market valuations higher and leaves the market susceptible to some selling on any disappointing news. The S&P 500 Volatility Index ended yesterday’s bullish session at just over 12, which is near a four-year low and reflective of an overbought market. That said, the latest Fed decision, which was viewed as a “goldilocks” report by Wall Street, has the potential to push stocks higher over the final two-plus weeks of this year, even with valuations looking frothy right now. It is worth noting that with fixed-income yields falling, we are seeing some movement by income-oriented investors into the higher-yielding equities, including the utilities, which were out of favor for a good portion of this fast-concluding year. – William G. Ferguson
At the time of this article’s writing, the author did not hold any positions in the companies mentioned.
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