- New York Fed head Williams hints rates may stay higher for longer and at tighter-than-expected policy
- Dallas Fed head Lorie Logan had hinted at an end to Quantitative Tightening and looser-than-expected policy
- Markets are still pricing in six one-quarter point rates cuts down to 4.00% by Christmas, according to CME Fedwatch
- No change expected at the FOMC meeting on 31 January, but consensus expectation is the first cut comes on 20 March
“According to the CME Fedwatch survey, US markets are expecting six one-quarter point interest rate cuts from the US Federal Reserve in 2024, so arguments from New York Fed chair John Williams that more needs to be done to ensure inflation is defeated may not be welcome,” says AJ Bell investment director Russ Mould. “Markets are pricing in a cooling of inflation, a soft landing and a pivot to interest rate cuts from the US Federal Reserve, so any different outcomes could stoke volatility at best and lead to disappointment at worst, bearing in mind how frantic Fed rate cuts did nothing to stop the development of equity bear markets in 2000-2003 and 2007-2009.
“The VIX – or fear – index is lurking below 13, well below its historic average of nearly 20, to suggest markets are at best complacent, at worst exuberant.
Source: CBOE data, LSEG Datastream data
“If the Fed moves too early – and chair Powell mirrors the mistakes of one of his predecessors, Arthur Burns, back in the 1970s, then inflation (or even a crack-up boom) could follow, with the result that interest rates do not come down as fast and as far as markets currently hope.
“Alternatively, a sharper-than-expected slowdown may mean the rate cuts arrive but for the ‘wrong’ reason, namely a hard landing, rather than a soft one. Investors with long memories will know that Fed intervention did nothing to stop the bear markets of 2000-03 or 2007-09, at least initially.
Source: LSEG Datastream data
“That was because earnings estimates were falling a lot faster than rates, as the US economy hit the buffers.
Source: LSEG Datastream data
“The dream middle path of cooler inflation, a soft landing and rate cuts may well transpire and in that case then all may be well and good. But if the Fed cuts interest rates because America’s government debts and the interest burden are too high, or the economy (and earnings) are on the slide, then markets may need to be careful about what they are wishing for.
“And this all matters, even to UK-based investors, since the US stock market represents almost two-thirds of total world stock market capitalisation, so it seems fair to assume that where America goes the world will follow, at least to some degree. Keeping an eye on the US political scene, Federal Reserve policy and the American economy may therefore help investors judge what 2024 (and beyond) may hold for their portfolios.
“By the same token, four sectors – technology, financials, healthcare and consumer discretionary – make up two thirds of the market value of the headline S&P 500 US equity index. Any investor who wants to cut down on the amount of research they wish to do can focus on those, in the knowledge they are looking at some of the most important companies and industries in the world, at least from the perspective of investment.
Source: Standard & Poor’s
“The near-one third weighting of the S&P 500 toward technology may leave those who remember 1998-2000’s technology, media and telecoms (TMT) bubble more than a little uncomfortable, although it may at least help to explain why the index, at around 20 times earnings for 2024, trades above its long-term average of 18 times, according to research from S&P.
“Even more intriguing is that the Magnificent Seven of Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA and Tesla (not all of which are classified as tech stocks) represent 30% of the S&P 500. Such a reliance on so few names is not always a healthy thing and if anything goes wrong with them then other stocks and sectors will need to take up the slack – financials, healthcare and consumer discretionary in this case. Two of those would presumably falter in the event of a nasty recession, even if lower interest rates could conceivably help the consumer-facing firms and the banks (which could also do with a steeper yield curve), although in the event of such a downturn then relatively defensive healthcare names could perhaps come to the fore and provide support to the headline equity indices.”
