The Roaring 20's?

Week in Review

At its final meeting of 2024, the Federal Reserve surprised markets with a more hawkish tone to its updated economic projections and "dot plot" (consensus forecast of FOMC members on the path of interest rates).

While the Fed did bring down the fed funds rate by 0.25% to a range of 4.25% - 4.5%, its dot plot indicated only two rate cuts in 2025, compared to the previous forecast of four cuts in September. This unexpected shift initially caused a negative reaction in the markets, with bond yields rising and stock prices falling sharply.

The Fed explained its decision by citing two key factors: the trajectory of inflation and uncertainties surrounding tariff policies in the coming year. Fed Chair Jerome Powell also emphasized the strength of the U.S. economy, stating that it is currently "in a really good place." Overall, we believe the fundamentals of the economy remain robust, and any market volatility presents opportunities for long-term investors.

While the Fed's more cautious approach to rate cuts may be justified by inflation remaining slightly above the target rate of 2%, and uncertainty around trade policies, we anticipate that interest rates will continue to trend downward over the next 12 months. This should be supportive for both consumer spending and borrowing costs for households and businesses.

In addition, it is worth noting that the markets had already priced in just two rate cuts for 2025, thus aligning with the Fed's updated dot plot. However, the Fed's bold move to reset market expectations could potentially provide a positive boost to market sentiment, along with the possibility of further rate cuts exceeding current expectations.

The ongoing bull market has been underpinned by a strong economy, steady earnings growth, and resilient consumer spending, even in the face of higher interest rates and elevated inflation. The Fed's recent meeting did not alter this narrative. In fact, it reinforced the notion that the economy is thriving, inflation is under control, and the Fed plans to continue lowering interest rates, although at a slower pace than initially projected.

Furthermore, last week's economic data further exemplified the strength of the U.S. economy. The annualized third-quarter GDP figures surpassed forecasts at 3.1%, driven by a robust consumption rate of 3.7%. Additionally, the Fed's GDP-Now forecast predicts a fourth-quarter GDP growth rate of approximately 3.2%. These numbers solidify the fact that the U.S. economy is expected to end the year above its typical trend of 1.5% - 2.0%. Overall, the data reaffirms the current health of the economy, providing further reassurance for investors.

Reflecting on the Rest of the Decade

In our optimistic view, the Roaring 2020s will bring about a period of high productivity growth, leading to increased real GDP, controlled inflation, higher wages, and more profitable businesses. The recent Productivity and Costs report released by the Bureau of Labor Statistics further supports this positive outlook. It is worth noting that geopolitical crises have not significantly affected the US economy or stock market in recent times.

Some of the potential factors include a tariff and currency war, a potential US Treasury debt crisis, and a rebound in inflation that would force the Fed to adjust their monetary policy. The resulting positive wealth effect from rising stock prices, as well as the prices of houses, real estate, bitcoin, and gold, could also contribute to consumer price inflation. This may force the Fed to increase interest rates, which could turn the melt-up into a meltdown. One of our outside views, which handcuffs the Fed, is that higher interest rates have increased housing inflation as it increased monthly payments on mortgages significantly which allowed landlords to increase rents.

The latest inflation data suggests that prices may be hovering just above the Fed's 2.0% target. Some experts argue that the inflation trend mirrors that of the 1970s - a period that saw an initial surge in inflation followed by a second wave in the latter half of the decade. During the 1970s, two geopolitical events in the Middle East caused a sharp increase in oil prices. While the current decade has already seen two geopolitical crises that could potentially drive-up oil prices, prices remain relatively stable. This is due to the abundance of global oil supply and a subdued demand for oil globally.

Earnings & Economic Calendar

The stock and bond markets will close early on Tuesday and remain closed on Wednesday in observance of Christmas.

Before then, there will be a few economic releases to take note of. On Monday, the Conference Board will release their Consumer Confidence Index for December, while the Census Bureau will share the durable goods report and residential sales data for November.

As for earnings, there are no major companies scheduled to report during the holiday week. However, the upcoming fourth-quarter earnings season will kick off on January 15 with results from major banks such as JPMorgan Chase, Citigroup, and Wells Fargo.

Chart of the Week: Managed cash falls as professional investors move to bonds.

Disclaimer: The author of this blog is a financial advisor but may not be the right advisor for you. In fact, the author may not even be the right advisor for themselves. Please consult a qualified professional before making any financial decisions based on the content of this blog. And remember, just because the author has a fancy title and a briefcase full of spreadsheets, doesn't mean they know what they're doing.