Wall Street Braces for Big Test of Dovish Fed Bets: Markets Wrap

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(Bloomberg) — Wall Street is gearing up for what’s expected to be the most-important Federal Reserve decision of the year, with traders awaiting any signals on whether the market’s aggressive dovish bid is now overdone.

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Stocks, bonds and the dollar saw mild moves amid bets the Fed will hold rates Wednesday and try to put a lid on expectations for rate cuts of over 100 basis points in the next 12 months. How the Fed frames its outlook for policy ending next year and 2025 via its “dot plot” could inject some uncertainty into the market that has run well ahead of the central bank’s forecasts.

The Federal Open Market Committee is set to keep rates in a range of 5.25% to 5.5% — a 22-year high. The decision is due at 2 p.m. Washington. Chair Jerome Powell will speak 30 minutes later. Economists surveyed by Bloomberg expect the median Fed projection will show two rate cuts next year and five more in 2025.

Ahead of the decision, data showed producer-price gains slowed as energy costs fell. Consumer prices Tuesday underscored a drop in the annual rate of inflation — even as monthly gains picked up. Taken together, the numbers reinforce the notion that inflation is trending back toward the Fed’s target.

The S&P 500 wavered near its highest since January 2022. Treasury two-year yields dropped below 4.7%. The greenback was little changed.

What Will the Fed Say?

“It will likely take Chairman Powell to throw some meaningful cold water on the ‘rate cut’ narrative today to slow this rally down. However, if (repeat, if) he does indeed do that, the markets are overbought enough that it could create a surprising decline.”

“Don’t get us wrong, it’s not like Mr. Powell has to use the kind of bucket of ice-cold water he did at the Jackson Hole Conference of 2022 to slow this rally down, but it’s certainly going to have to be ‘colder’ than anything he or other members of the Fed have used over the past couple of weeks. Otherwise, any further upside follow-through in the stock market this week is going to make a retest of the all-time highs before the end of the year a distinct possibility.”

“The market’s optimism regarding five rate cuts in 2024 may very well be tested this afternoon, with the committee perhaps only envisioning two.”

“If today’s Summary of Economic Projections, or dot plot, portrays expectations among policymakers for only two cuts next year, Powell will have to explain why the Fed believes extended monetary policy tightening is needed. Additionally, markets are likely to respond with increased volatility.”

“In contrast, a dot plot that is consistent with investors’ expectations and a quiet day for climate protestors could give Powell a break and cause equities to surge upward today. Given the strength and velocity of the rally, however, the former case is more likely as further upside in stocks is difficult to envision.”

“I doubt we will hear any strong messages about further tightening. I suspect FOMC officials will signal a few rate cuts in 2024 in the dot plots, effectively pushing back against market expectations of about 125 basis points rate reduction. Whether the market will believe the Fed is another question, however.”

“We believe the markets are priced for near-term disappointment. We struggle to embrace the consensus logic calling for 12% profit growth and more than 100 bps in rate cuts in 2024. Recent data on inflation, employment, and Jerome Powell’s persistent messaging are inconsistent with the market’s optimism.”

“Consequently, it’s likely the Fed will keep its projection of a 5.1% fed funds rate by year-end 2024, leading to higher market interest rates and a potential test of the S&P 500’s 50-day moving average around 4,400 — which would represent a drop of approximately 5% from current levels.”

“Will the 2024 Dot stay at 5.125% (one cut implied) or move down to 4.875% (two cuts)? Either one would suggest limited scope for rate cuts next year. We certainly don’t expect a more dovish 2024 dot of 4.625% (three cuts), as this would simply feed into the dovish Fed narrative. The 2025 and 2026 dots have little meaning right now and are unlikely to shift much.”

“The Fed continues to signal a willingness to keep policy tight for an extended period to help make sure inflation falls. The message from the Fed has been that short-term rates will be higher for longer, but without much detail. The market has gotten ahead of the Fed in anticipating rate cuts a few times over the past year only to have to unwind those expectations, causing yields to rebound sharply.”

“We expect the Chair will use this opportunity to 1) reinforce the Committee’s higher-for-longer messaging by reiterating that it would be premature to declare victory on inflation, and 2) maintain a degree of symmetry around the FOMC’s future rate decisions in an effort to dissuade the market from price in near-term rate cuts.”

“Any acknowledgment of rate cuts next year could be well received, although only one may receive a cool response as that would suggest policymakers view it as coming very late in the year. Traders may well shake on two as that would point to a third-quarter rate cut which seems odd as that still wouldn’t be nearly as aggressively as markets are positioned but it’s unlikely the Fed will pivot to the extent that it aligns with the very optimistic expectation currently priced into the markets. That isn’t to say they won’t get there over the next few months.”

“The market will focus on the median end-2024 dot, but the range of estimates will also be important. The question is how much Powell’s press conference and the dot plot push back against market expectations for at least 100 basis points of monetary easing next year.”

“The keys are the 2024 dot (does it show 50 bps of cuts?) and whether Powell slams the door on the idea of rate cuts (or leaves it slightly open). Unless he blatantly admonishes the market’s opinion as too optimistic, don’t expect a pullback because Powell reiterating rate cuts are a consideration right now won’t change investor opinions. Essentially, this powerful belief makes the bar for a hawkish disappointment very high and that’s good for the Santa rally.”

“The Fed is approaching the point at which it will need to adjust its rhetoric to prepare investors, policymakers, and the public for cuts in the policy rate around the middle of next year.”

Treasury Secretary Janet Yellen said it would make sense for the Fed to consider lowering interest rates as inflation eases to keep the economy on an even keel.

“As inflation moves down, in a way, it’s natural that interest rates come down somewhat because real interest rates would otherwise increase, which would tend to tighten financial conditions,” Yellen said Wednesday in an interview on CNBC.

Mark Haefele at UBS Global Wealth Management, says that while he expects rates to come down in 2024 — supporting both equity and bond markets — the speed of recent gains is likely to moderate.

“In particular, we now only see modest upside for global and US equities. With economic growth set to slow, quality stocks are likely to outperform in our view, the firm’s chief investment officer noted.

Even a slight pushback from the Fed on interest-rate cuts could unravel the relentless stock rally since late October.

“We have this cohort modeled to sell S&P 500 in every scenario over the next week,” Goldman Sachs Group Inc. derivatives and flow specialist Cullen Morgan wrote in a note to clients. It follows a warning from his colleagues last week that dangerously high optimism on stocks means there are “no longer any bears left.”

The outlook for US stocks is poised to be better than many assume heading into 2024 even if the economy is showing signs of slowing as key models suggest, according to Bloomberg Intelligence.

Historically, the S&P 500 Index has delivered strong returns the year after BI’s Economic Regime Model first falls below .03, or the Conference Board’s index of leading economic indicators (LEI) declines more than 7.6% from a year earlier — as both did in October, according to data compiled by BI.

“The impressive market momentum continues to provide a tailwind through year end, assuming the FOMC release doesn’t dramatically shift expectations,” said Mark Hackett, chief of investment research at Nationwide. “Increasingly, the macro backdrop reinforces that optimism, with easing inflation, improving financial conditions, and gradually improving sentiment.”

Elsewhere, traders ramped up bets on interest-rate cuts by the Bank of England next year after soft GDP data reinforced the view that policymakers won’t be able to keep monetary policy tight for so long. For the first time in the current cycle, markets fully priced 100 basis points of monetary easing in 2024, which would take borrowing costs to 4.25%.

Oil rose as a strong drawdown in US stockpiles helped thaw a market frozen by concerns about excess supplies.

Read: Crude Inventories Fall Ahead of Year-End Taxes: EIA Takeaways

Corporate Highlights:

  • Apple Inc. is set to be hit by a ban on its App Store rules that govern music-streaming rivals and a potential hefty fine in the European Union’s latest attempt to limit the power of Big Tech.

  • Tesla Inc. will fix more than 2 million vehicles — its biggest recall ever — after the top US auto-safety regulator determined its driver-assistance system Autopilot doesn’t do enough to guard against misuse.

  • SpaceX will sell insider shares at $97 apiece in a tender offer, a price increase that boosts the value of Elon Musk’s space and satellite company closer to $180 billion, according to people familiar with the matter.

  • Pfizer Inc.’s disappointing forecast for next year showed the purchase of a leading cancer drugmaker isn’t enough to fill the ever-growing hole from its flailing Covid franchise.

  • Southwest Airlines Co. raised its outlook for fourth-quarter revenue, buoyed by higher travel demand and ticket prices than it had expected over the year-end holidays.

  • Exxon Mobil Corp. introduced a new compensation policy that would pay some traders cash bonuses, a significant change within the US energy giant as it looks to expand its trading operations.

  • Coinbase Global Inc. is rolling out spot crypto trading on its international exchange as part of a global expansion, saying some users are wary of US venues due to the country’s uncertain regulatory backdrop.

Key events this week:

  • European Central Bank policy meeting followed by news conference with ECB President Christine Lagarde, Thursday

  • Bank of England policy meeting, Thursday

  • Swiss National Bank policy meeting, Thursday

  • US initial jobless claims, retail sales, business inventories, Thursday

  • China 1-yr MLF rate and volume, property prices, retail sales, industrial production, jobless rate, Friday

  • Eurozone S&P Global Manufacturing PMI, S&P Global Services PMI, Friday

  • US industrial production, Empire manufacturing, S&P Global US Manufacturing PMI, Friday

Some of the main moves in markets:

Stocks

  • The S&P 500 was little changed as of 1:30 p.m. New York time

  • The Nasdaq 100 was little changed

  • The Dow Jones Industrial Average was little changed

  • The MSCI World index was little changed

Currencies

  • The Bloomberg Dollar Spot Index rose 0.1%

  • The euro was little changed at $1.0784

  • The British pound fell 0.5% to $1.2502

  • The Japanese yen rose 0.2% to 145.20 per dollar

Cryptocurrencies

  • Bitcoin rose 2.3% to $42,013.79

  • Ether rose 1.8% to $2,210.27

Bonds

  • The yield on 10-year Treasuries declined four basis points to 4.16%

  • Germany’s 10-year yield declined five basis points to 2.17%

  • Britain’s 10-year yield declined 14 basis points to 3.83%

Commodities

  • West Texas Intermediate crude rose 0.7% to $69.11 a barrel

  • Spot gold rose 0.1% to $1,982.14 an ounce

This story was produced with the assistance of Bloomberg Automation.

–With assistance from Jan-Patrick Barnert, Michael Msika and Jessica Menton.

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