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It’s true that 2023 ended on a high note, punctuated by sharp rallies in both the stock and bond markets, tangible evidence that the economy is on a steady disinflationary growth path, and strong indications that the Fed is poised to cut rates in 2024. The soft-landing scenario that most economists and investors scoffed at early last year now seems more likely to play out. This about-face in prospects was strikingly echoed in the financial markets as 2023 drew to a close. Stocks recouped all their losses suffered in 2022, while market yields erased a good part of the surge over the first 10 months of 2023. Indeed, an investor in the 10-year Treasury security who went into hibernation at the start of the year and awoke at its end might think that nothing of note occurred over the period. That’s because the yield wound up at the same place it started, completing a round trip journey from 3.88 percent to just over five percent in October and back down to 3.88 percent on December 31.
The era of low rates ended in March 2022 when the Federal Reserve belatedly started the most aggressive rate-hiking campaign in a generation, lifting its policy rate 11 times from near zero to a range of 5.25-5.50 percent in July of 2023, where it has remained. Until a few weeks ago, the central bank has wavered over what to do next – raise again or keep them “higher for longer.” The bias towards a more belt-tightening policy was understandable: inflation remained far above the Fed’s two percent target and, importantly, the rate hikes seemed to have had little effect on the economy. Indeed, GDP accelerated to an eye-opening 4.9 percent growth rate in the third quarter and the unemployment has remained under four percent for 22 consecutive months – the longest stretch since the 1960s.
The week was devoid of significant economic data, with only sales of existing homes and claims for unemployment benefits on the calendar. There were neither market-moving events, nor did they provide any surprises. Perhaps no news constituted good news for a market that has been buffeted by noisy and conflicting reports on inflation, as well as the economy's performance during the opening month of the year. Stock prices did hit fresh records on Thursday, as the headline-grabbing chip maker, Nvidia, reported blockbuster results, highlighting the ongoing positive influence the AI revolution is having on investor expectations. To be sure, the stock market is not the economy, as economists repeatedly caution. But nor is it not related to economic developments. The $277 billion increase in Nvidia's stock value on Thursday contributes to the wealth effect of its holders, as well as to the portfolios of the broader stock-holding public. This, in turn, does have an impact on consumer spending, although one that is not as powerful as the boost provided by income growth. There is also a modest feedback loop to the job market, as managers of corporations whose stocks are rising are under less pressure to lay off workers.
Trying to parse this week's batch of economic data invites a splitting headache. For its part, the stock market received a modest case of whiplash, lurching back after absorbing a hotter than expected inflation report, but recovering in response to data revealing cooler economic activity. A Goldilocks scenario may still be unfolding, but the porridge was either too hot or too cold to satisfy the tastebuds of skeptical economists. From our lens, incoming data should be viewed with a healthy dose of caution, as January figures tend to be the noisiest of the calendar, reflecting the volatile effects of holidays, weather and one-offs that appear during the first month of the year.
The economy keeps on chugging along, reducing recession fears even further while heightening prospects of a soft landing. The downside of this otherwise brighter outlook is that it pushes back the timetable for a Fed rate cut, which most thought would take place as early as March. Fed Chair Powell put the kibosh on that expectation in the press conference following the last policy meeting, and Fed officials have continued to push back on the notion of an imminent rate reduction ever since. That said, policymakers are not straying from their plan to cut this year, but it most likely will not happen until May at the earliest.
Friday's blockbuster jobs report makes it further unlikely that the Fed will cut interest rates as early as March, which most traders thought would take place heading into the FOMC meeting this week. To be sure, support for the early move had been waning due to the upside surprises contained in incoming data. But Chair Powell's comments in the post-meeting press conference were more definitive on the issue, noting that more time is needed before the Fed feels sufficiently confident that inflation is firmly on the path to its two percent target. While key price measures have hovered at or even slightly below the target over the past six months, Powell and his colleagues are still highly sensitive to the risk of moving prematurely and allowing the inflation embers to reignite.