Investors cheer Fed’s dovish pivot, as focus shifts to 2024 risks

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Seventeen out of 19 Fed officials project that the policy rate will be lower by the end of 2024 than it is now – with the median projection showing a fall to 4.6% from the current 5.25%-5.50% range. That compares with a rate of 3.847% reflected in futures to the Fed’s policy rate, LSEG data showed.
| Photo Credit: CARLO ALLEGRI

A dovish shift from the Federal Reserve has put record highs in sight for U.S. stocks, even as some investors worry the market may be moving too fast given an uncertain outlook for the economy and corporate earnings.

The Fed held interest rates steady on Wednesday and signaled in new economic projections that the historic tightening of U.S. monetary policy engineered over the last two years is at an end and lower borrowing costs are coming in 2024.

The message was more dovish than many investors were expecting. Plunging Treasury yields helped the S&P 500 rise nearly 1.4% on Wednesday, the biggest gain in the index on a day that the Fed issued its monetary policy statement since July 2022. The benchmark U.S. 10-year Treasury yield, which moves inversely to bond prices, fell to around 3.99% in late Wednesday trading, the lowest level in four month..

“The Fed is done raising rates, and the market could not be more thrilled to have higher conviction in that,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management.

The Fed’s view is now more aligned with that of investors – though markets remain far more dovish in their outlook.

Seventeen out of 19 Fed officials project that the policy rate will be lower by the end of 2024 than it is now – with the median projection showing a fall to 4.6% from the current 5.25%-5.50% range. That compares with a rate of 3.847% reflected in futures to the Fed’s policy rate, LSEG data showed.

With few major macroeconomic events expected for the rest of December, the S&P 500 could have the momentum to end the year by matching or exceeding the closing high it set in January 2022. The index is now less than 2% below that record of 4,796.56. The Dow Jones Industrial Average marked a record high close on Wednesday, its first since January 2022, along with shares of Apple Inc, the world’s most valuable company.

Seasonal factors could provide a tailwind: December has been the third-best month for the S&P 500 since 1950, with the second half of the month typically stronger than the first, according to data from LPL Financial.

Support could also come from formerly bearish investors’ abandoning their positions. Data from BofA Global Research showed that leveraged funds “are not bullish and continue to fight rallies” in stocks after increasing their net short in the face of the S&P 500’s fourth-quarter rebound, the bank said in a recent report.

“It’s getting hard for bears to have something to point to,” said Jack Janasiewicz, a portfolio manager at Natixis Investment Managers Solutions, who recently increased his equity exposure to take advantage of seasonal trends.

Still, many investors are wondering how much of the Fed’s dovishness has already been priced in during a rally that has seen the S&P 500 rise more than 22% this year. Next year, the economy must walk a fine line to satisfy the “Goldilocks” narrative of cooling inflation coupled with still-resilient growth.

“Into this year, the market had gotten cheaper … sentiment was bearish. Now you go into next year, the consensus is soft landing, the multiple is much higher, the earnings estimates are higher, and I think that is going to make it a tougher market environment,” said Miskin, whose firm is modestly underweight stocks versus bonds, reflecting somewhat defensive positioning.

The S&P 500 was recently trading at 19.1 times forward earnings estimates, versus its long-term average of 15.6 times, according to LSEG Datastream. S&P 500 company earnings are expected to rise 11.4% in 2024, after a 2.6% increase in 2023, according to LSEG data.

Mike Sanders, head of fixed income at Madison Investments, said the market is “far, far more aggressive in cuts than even what the Fed let on in a very dovish statement.”

The key focus of the next six months will be whether inflation can continue to fall while the jobs market remains stable, said Sanders, who is bullish five-year Treasuries. “We need to be certain that the soft landing isn’t just a prelude for a hard landing,” he said.

Carol Schleif, chief investment officer with the BMO Family Office, will be watching the health of the consumer as “we finish out the holiday season,” including how consumers “are able to absorb higher credit card bills when they come in January after the holiday selling season.”

Jason Pride, chief of investment strategy and research at Glenmede, said the Fed’s latest economic projections appear to forecast a soft landing.

“However, there has never been an instance where rates have remained this high for this long without causing collateral damage for the economy,” Pride said.

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