Presented by Nicholas Wealth Management
Expectations for a soft landing fuel new records in U.S. stocks
After a rough first couple of weeks to open 2024, markets have been ripping the past week and a half. We’ve settled into an interesting environment where the talk has gone from a hard landing, recession and four rate hikes in 2023 to a soft landing and six possible rate cuts in 2024. The markets are expecting rates to begin coming down in May or June. The problem with that timeline? There are only eight meetings total for the Federal Open Market Committee in 2024 — six of them happening after April 30. That means the Fed would need to cut rates by 25 basis points (0.25%) at every meeting through the rest of the year, including up to and through November elections.
The Fed has traditionally laid low during election years, with the recent exception of 2008. (We had much more to worry about back then.) The conundrum now is that if the market expects the Fed to cut rates six times (for a total of 1.5%) to move us closer to a Fed funds rate of 4% and if the Fed wants to avoid looking like it’s putting its thumb on the election scales, it will need to cut 50 basis points (0.50%) at the May, June and July meetings.
Sure, that would satisfy the six cuts the markets expect and keep the Fed quiet through the elections. It would also satisfy the Fed’s stated guidance that it would only cut three times. However, three 50-basis-point cuts in three successive meetings may also signal that the economy is in trouble.
This is a very tiny needle to thread, and the possibility of something unexpected coming along to upset that delicate calculation seems to be high. Three potential events come to mind:
- An uptick in inflation as we move into the summer. Inflation has hovered stubbornly over 3%, well above the Fed’s stated target. If we see inflation move higher, that will give the Fed an excuse not to cut.
- The consumer rolls over. So far, the consumer has kept the economy afloat. Higher rates on high credit card balances may slow spending, which could lead to slower economic growth and spur the Fed to cut more aggressively. This could freak out the market because it would signal we are headed for recession.
- Any event that might spike gas prices. We’ve said before that energy prices are a key component of inflation, whether the official estimates include them or not. High energy prices keep inflation high — and as we said earlier, high inflation will give the Fed reason to hold off on lowering rates.
There’s no way to avoid unexpected challenges, whatever form they may take. For now, let’s just enjoy the market’s run.
Markets are moving forward despite slowing earnings and GDP
Early fourth-quarter earnings have been so-so thus far. The first reading of the fourth-quarter gross domestic product (GDP) came in at 3.3% last week, down from 4.9% in the third quarter. That’s up from Wall Street’s consensus expectations of 2% growth in the final three months of the year, fueling conversations about a soft landing.
Softer earnings were expected, as was a GDP slowdown from the third to fourth quarter. The fact that GDP didn’t slow as much as forecasted and was actually a bit stronger may lead some to think the Fed may be inclined to leave rates where they are a bit longer and trade lower growth to tame inflation further. But the longer the Fed waits, the smaller the eye of the needle it needs to thread gets before the election. The markets may be painting themselves into a corner with how soon and how many rate cuts we will get in 2024.
For now, those worries are very distant. The markets seem content to push higher, relying on soft-landing expectations and rate cuts down the road. Remember, the narrative can change on a dime; markets may decide that rates will not decline to the expected levels. However, if we continue to experience a soft landing and earnings strengthen, that may be enough to make up for the disappointment. Markets tend to spook easily when they start touching new highs and enter uncharted territory, so a healthy 5% or even 10% pullback would not be unheard of. As we see the narrative change, we may see markets pull back in April or May and struggle in the summer months. Then we will grapple with the results of the elections, recovering and advancing as we end 2024.
Coming this week
- The Fed is meeting on Tuesday and Wednesday this week. Expectations right now are for the Fed to stay put at the 5.25% to 5.5% level. There is a slim chance of a quarter-point drop in January, but expectations are for a decline in March and then another in May.
- We’ll get the ADP jobs report early Wednesday, although too late to play into the Fed’s decision. If the report continues to show strong job creation, it may upset the market’s narrative on when and how many rate cuts we can expect.
- Earnings will continue to come out all week. We’ll also see the Job Openings and Labor Turnover Summary (JOLTS) number for December as well as the latest Consumer Confidence Index on Tuesday.
- MBA mortgage applications will come out on Wednesday, followed by the latest weekly unemployment claims on Thursday.
- We’ll close out the week with the Bureau of Labor Statistics (BLS) non-farms payroll on Friday. Once again, the market will look for weakness in growth and wages, but not so much as to signal panic. Jobs and wages have been growing at a slower pace, and that has fueled talk of a soft landing and expectations for lower rates.
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