The Fed holds rates steady but points toward three cuts in 2024 … Wall Street is pricing in even more cuts … what “normalization theory” is telling us … how to catch last night’s replay
Today, the Federal Reserve kept target rates at 5.25% – 5.50% as was widely expected.
What wasn’t widely expected was the dramatic shift in the Fed’s forward guidance.
As we noted in yesterday’s Digest, the more revealing part of today’s meeting was likely to be the updated “Dot Plot.” This is a graphical representation that shows us each committee member’s anonymous projection of where they believe rates will be at upcoming dates in the future.
Well, revealing it was.
Whereas the most recent Fed Dot Plot from late-September showed a median projection of just one rate cut in 2024, today’s updated Dot Plot shows three quarter-point rate cuts coming.
And though Federal Reserve Chairman Jerome Powell was careful not to rule out higher rates if necessary, he sounded very dovish in his press conference, noting “inflation has eased from its highs, and this has come without a significant increase in unemployment. That’s very good news.”
The markets exploded higher in the wake of the today’s meeting. All three major indexes ended up more than 1%, with the Dow crossing 37,000 to set a new all-time-high at 37,090.
This reaction is understandable. And though we’ve been cautious here in the Digest this fall, even we’re excited by today’s news since it addresses one of the biggest concerns we’ve had – namely, that Wall Street has been pricing in more cuts from the Fed in 2024 than the Fed would be likely to deliver.
However, while this updated Dot Plot alleviates some of those concerns, we’re also seeing – in real time – Wall Street pushing expectations yet again.
Let’s dig into what’s happening…
One of the risks we saw for 2024 was the misalignment between Wall Street expectations and the potential for Fed follow-through
To make sure we’re all on the same page, Wall Street is a forward-looking pricing mechanism. It typically gazes out about 12 months into the future, trying to price stocks in anticipation of what’s coming.
You’ve likely heard the phrase “buy the rumor, sell the news.” This is the forward-looking pricing mechanism in action.
Wall Street often bids up a stock in anticipation of a coming bullish event (say a product release or update), and when it finally arrives, those early movers sell to the latecomers. They take their profits, leaving the latecomers scratching their heads as to why they’re suddenly underwater.
As we look to 2024, we have two different-yet-related variables – the economy and the stock market.
Over a longer timeframe, the strength of the economy drives the stock market (through earnings). But in shorter periods, Wall Street and the economy often move in opposite directions. As we just saw, Wall Street likes to push asset prices around in anticipation of future economic conditions (and by extension, how earnings will fare).
If Wall Street gets it right, its “buy the rumor” advanced pricing will make them money as they unload their shares on more cautious latecomers. If Wall Street get it wrong, then we often see a frantic selloff as it tries to unload busted wagers in the face of news that didn’t pan out as expected.
The big bet Wall Street is making today making centers on 2024 rate cut timing and size
In recent weeks, as expectations for a soft landing in 2024 have intensified, Wall Street has ramped up its bets on the timing and scope of rate cuts next year.
Prior to today’s Fed meeting, traders were pricing in a majority expectation of five quarter-point cuts by this time next year (a December 2024 target rate of 4.00% – 4.25%). Plus, the starting clock for when these rate cuts will begin has moved forward in recent weeks.
Again, before today’s Fed meeting, most traders (50.5%) believed we’d get the first rate cut in May. One month ago, those odds clocked in at just 29.6%.
Given September’s Dot Plot forecast of just one rate cut in 2024, we had concerns about this incongruence between Wall Street expectation and Fed reality. We feared a market selloff in 2024 when the Fed ultimately disappointed Wall Street’s expectations.
But with today’s updated Dot Plot, our concerns have eased somewhat. With the Fed penciling in three rate cuts next year, that’s far closer to Wall Street’s expectation of five cuts.
But that’s not the whole story…
In the wake of today’s Fed meeting, Wall Street is readjusting its expectations
Now, instead of five cuts next year, it’s putting the heaviest odds on six cuts by this time next year for a target Fed Funds rate of 3.75% – 5.00%. So, double what the Fed projects.
And what about timing?
We just saw that coming into today, Wall Street put the highest probability of the first rate cut in May.
Well, after today’s news, the expectation is for the first cut March – by a landslide.
Now, two things can be true at once…
Yes, Wall Street is justified to be celebrating based on today’s news from the Fed.
However, also yes, Wall Street could be getting ahead of itself in its expectations of the Fed next year, which sets up the potential for what we had hoped to avoid…
Disappointment.
For a deeper look at this, let’s turn to Louis Navellier’s favorite economist, Ed Yardeni.
Could a 2024 economic normalization result in turbulence…then a takeoff?
Yardeni is bull. You might have seen an article in CNBC yesterday in which he called for the S&P to hit 6,000 by 2025. We’ll circle back to that in a moment. First, let’s look at his expectation for 2024.
Yardeni has long said that we’ll avoid a recession next year. Over the fall, he’s detailed a handful of reasons why, but let’s focus on his most recent one from this week.
From Yardeni:
Perhaps the Fed hasn’t been tightening monetary policy so much as normalizing it.
Interest rates are back to the Old Normal. They are back to where they were before the New Abnormal period between the Great Financial Crisis and the Great Virus Crisis, during which the Fed pegged interest rates near zero.
This rings true to us.
As we’ve highlighted here in the Digest, the halcyon days of 2010 – 2020 with anemic inflation, 0% interest rates, and slow growth were an abnormality that fueled stock gains. Yet many investors have come to think of that decade’s conditions as normal.
The reality is that long-term “normal” means higher inflation and higher interest rates. YCharts reports that the long-term average Fed Funds rate is 4.60%. And the median forecast in today’s updated Dot Plot has the federal funds rate ending 2024 at, you guessed it, 4.60%.
Well, we just saw how Wall Street is pricing in a Fed Funds rate of 3.75% – 4.00% by this time next year.
For this to be the case, then Wall Street 1) has become confused about what a return to “normal” means, or 2) believes lower rates will be needed to aid an ailing economy.
Given how most analysts now embrace an economic soft landing, it’s most likely not explanation #2.
Let’s go back to Yardeni:
The normalization theory implies that the Fed might not lower interest rates next year as much as widely expected. That’s because the economy wouldn’t require as much easing to reverse the tightening after the tightening has done its job of bringing down inflation.
If the economy remains resilient but inflation continues to fall closer to the Fed’s 2.0% target next year—both of which we’re expecting—then the Fed might lower the federal funds rate twice next year, by 25bps each time, instead of four times or more as widely anticipated.
As we now know, the Fed is targeting three quarter-point cuts, but Wall Street is pricing in six.
This incongruence between the normalization theory and Wall Street’s “soft-landing-2010-conditions” pricing represents a potential selloff in 2024.
Now, while that could ruffle a few portfolios, let’s pick up our head and look farther out.
Why Yardeni sees the S&P at 6,000 in two years
There’s no shot clock in investing.
Even if there’s turbulence in 2024 based on the incongruence we just highlighted, that wouldn’t be the end of the story.
After all, if the economy truly is normalizing, that’s long-term bullish. Sure, there’s the chance Wall Street is mispricing rate cuts, but if we are skirting a recession and laying a foundation for long-term growth, that’s supportive of higher asset prices to come – even if there’s market turbulence between now and then.
This is partially why Yardeni expects the S&P to leap 30% by the end of 2025.
From CNBC:
His forecast assumes 2026 earnings for the S&P 500 of $300 per share, and a forward price-to-earnings ratio of 20.
“That’s because we are seeing more reasons to believe in our Roaring 2020s scenario — the theory that productivity growth, driven by technological solutions to the labor market’s supply/demand imbalance, will lead to strong economic growth throughout this decade,” Yardeni said in a note to clients Sunday evening.
Nevertheless, between now and then, there’s potential for 2024 volatility if the Fed doesn’t match expectations. So, how might this influence how investors position themselves today?
That brings us to last night…
Yesterday evening, our InvestorPlace expert analysts detailed their forecasts for 2024 rate cuts, economic growth, and market performance
As expected, the Early Warning Summit 2024 was an enormous evening, attended by tens of thousands of investors wanting a leg up on next year.
Louis Navellier, Eric Fry, and Luke Lango detailed their expectations for what’s on the way, as well as how investors should be positioning themselves today.
There were insights about inflation, rate cuts, market returns, sector performance, artificial intelligence, where to be positioned right now, which sectors to avoid next year…
The evening was chock full of valuable market commentary. If you missed it, you can check out the free replay right here. You’ll get loads of actionable market analysis from three of the best analysts in the business – not to mention, three of their top stock recommendations for 2024, totally free.
Coming full circle, we’re pleased by the outcome of today’s Federal Reserve meeting. And even if Wall Street is partying too hard and too fast, there are growing reasons to be excited about what’s on the way.
Have a good evening,
Jeff Remsburg
