Weekly Thoughts: December 23, 2024
Last week was centered around the FOMC rate decision and as expected, the FFR was cut 25bps to 4.25-4.50%. However, this was termed a “hawkish cut” as investors were more concerned with the Fed’s projected forecast for 2025 than they were excited by the December cut. The Fed’s forward looking “dot plot” which is a gauge of policy makers’ future expectations showed a predicted two more cuts in 2025, down from four. The equity market reaction was swift as investors suddenly were concerned with “sticky inflation” which really isn’t a new concept but the reality of fewer 2025 cuts took a market priced for perfection into an afternoon drop of 3.0% in the S&P, 3.6% in the Nasdaq and over 4% for the R2000 Small Cap Index. It is perplexing that this was the outcome as this was consensus expectations. We believe that Chair Powell’s verbiage—such as saying this cut was a “close call” which was verified by four dissenting votes on the committee may have take equity investors by surprise.
While pundits provided color on how to analyze where the FOMC may be going and decipher what they are thinking, Steve Wyett, CIS at BOK Financial described it as “Nuanced…The path to their 2% inflation goal was lengthened as expected cuts…next year were reduced. Unemployment is stable and the GDP forecast raised this year and appears stable in 2025 and 2026. There seems to be a sense the Fed is still too restrictive which puts the employment market at risk while the idea of continued economic growth means they think they can and should slow down. The question of where neutral actually is remains an open question.” While our view is they are still well above neutral, the stability of growth for now and the stubborn nature of inflation at current levels makes their caution reasonable.
The reaction on Wednesday afternoon sent waves of selling in the treasury bond market as the 10-year pierced 4.50% to close at 4.57% and the 2-year popped +11bps to 4.348%. In the days leading up to the Wednesday FOMC result, the consensus was for a 25bp cut but with a “hawkish” tilt. Apparently, markets were not as prepared as one would think when the narrative basically got the outcome correct. However, the reality in a generously priced equity backdrop is often more chilling than one may expect. Furthermore, on Thursday, yields held in this area and data released put the revised Q3 GDP at +3.1% from 2.8%, ?further solidifying the case that growth is quite robust heading into the turn of the calendar.
Other data included a second consecutive monthly rise in existing home sales which is a positive development in a challenged and expensive real estate market. On the contrary side of the ledger, with the pop in yields recently, the 30-year fixed rate mortgage level is back above 7% and that has two negative effects on housing sales. First, buyer’s borrowing costs are high while prices haven’t eased to help improve affordability. Second, on the existing sales side, home owners with mortgages in the 3-4% range loathe to sell their home only to purchase another and raise their interest expense. Thus, existing home supply will remain tight.
The major data continued on Friday with the PCE Index and the results were modestly better than expected. Nov was +0.1% versus an expected +0.2% and the YOY result was +2.4% versus +2.5%. The Core was also better, rising +0.1 vs. +0.2% and YOY +2.8% vs +2.9%. The better results led to a recovery from deep pre-market futures losses as the morning progressed and another narrative shift occurred stating maybe the “hawkish cut” from the FOMC was interpreted in too severe a manner as inflation actually improved. While true, we view the week’s news in totality as increasing Fed uncertainty about inflation’s path and despite the modest beat, the trend remains that improvement has stalled and the Fed will be cautious about the speed of rate cuts. ?Economy remains in a strong environment and inflation is sticky. It is that simple. There is an over analysis going on. Data dependent is often the stated plan but at the moment, the Fed primary theory of the path of the economy and inflation can and will shift. Equity investors must get their minds around the rate regime we are in and what multiples are justified in stocks.
The Fed statement combined with the economic reports released have adjusted the post-election narrative for the markets. The euphoria, measured by bull/bear sentiment and the enormous moves in a few stocks in short time left the markets ripe for a volatile shift in direction. Whether this week’s volatility leads to a larger decline, [for the week, S&P -2.07%, Nasdaq fell -1.88% and the R2000 was hit -5.09% despite ~1.00% rallies on Friday] investors must understand that rates are not coming down as fast as hoped and the ultimate injector of discipline, the bond market, will have a say in equity valuation. With various inflation measures between 2.5% & 3.2%, as well as our massive debt, [meaning treasury must continue large issuance] one can make a case that longer dated debt should have higher yields than the present levels.
Floating in the backdrop of the market and the economic reports is the seemingly omnipresent “DC Dysfunction” with a looming government shutdown. A bill backed by President-elect Trump went down in flames. The bill was a temporary funding plan and failed by 235-174, included 38 defiant Republicans.
Markets are used to this periodic dance and usually come to the conclusion that a deal or extension will happen—if not imminently, usually after just a few days of shutdown. Our guess is that some stop gap will be created by late Friday [writing as of Friday late afternoon] as our representatives are bumping up against the Christmas holiday and they want to go home.
The coming week should be low volume trading as economic data is sparse and of course, Christmas falls on Wednesday. The week between Christmas and New Year’s Day is usually low volume and volatility as portfolio managers have made year-end adjustments in advance and many senior folks are on vacation. However, one should always be alert as any news of significance can have an outsized affect in either direction due to thinly traded markets.
Our team here at Empire wish all a happy & healthy holiday season.