Written by Saqib Iqbal Ahmed
NEW YORK (Reuters) – A strong U.S. economy and pushback from central bank officials is causing some investors to reconsider their bets on how quickly the Federal Reserve will cut interest rates this year. This change has spread not only to the stock market but also to the Treasury market and foreign exchange market. It is near record highs.
After the most aggressive tightening cycle in decades, expectations that the Fed would ease monetary policy in 2024 fueled an explosive rally in stocks and bonds in the final months of last year, pushing the S&P 500 It recorded an annual increase of more than 24%.
Investors still believe rates will be cut, but some are questioning when the Fed will start lowering borrowing costs and how quickly. While the S&P 500 Index hit a new record high this month, U.S. Treasuries pared some of their gains and the dollar rose again.
Comments after the Fed's next policy meeting on January 30 and 31 could shed more light on how the central bank views the recent strength of the economy and the timing of rate cuts.
“The market looks like the Fed is looking through rose-tinted glasses until the end of 2023,” said Helen Given, a foreign exchange trader at Monex USA in Washington. “As we enter the new year, price expectations have started to change.”
A dovish shift at the Federal Reserve's monetary policy meeting in December raised investors' hopes that the central bank's tightening cycle is over and a rate cut is on the horizon.
In recent days, several officials have said they need more evidence that inflation will return to and remain at the central bank's 2% target before committing to cutting rates, suggesting monetary easing is imminent. I'm opposed to that view. Evidence that the economic sector remains strong supports that view.
As a result, investors now expect the Fed to make its first rate cut in May rather than March. Federal funds futures on Tuesday suggested a 41% chance of at least one rate cut at the March Fed meeting, down from 88% a month ago.
Among the data showing the economy's resilience is that retail sales and consumer prices rose more than expected in December.
Investors are waiting for December personal consumption expenditure (PCE) figures, another key inflation indicator, to be released on January 26th.
“Given the strength of both economic growth and wage growth, the Fed still needs to be concerned about the medium-term inflation outlook,” said Brian Rose, senior economist at UBS Global Wealth Management. .
Financial conditions, a measure of the availability of financing in the economy, eased sharply in the second half of 2023 as stock prices soared and bond yields fell.
Some investors argue that if yields continue to fall, financial conditions will become uncomfortably accommodating for the Fed, and the central bank will need to keep raising interest rates to prevent a rebound in inflation.
The Goldman Sachs Financial Conditions Index was at 99.39, not far from the 16-month low of 99.21 hit in late December.
“Current economic conditions are far from the conditions that have historically led to rate cuts,” John Lynch, chief investment officer at Comerica Wealth Management, said in a note Tuesday.
U.S. Treasury yields rose on stronger-than-expected economic data, with Treasury yields rising in contrast to bond prices. The yield on the benchmark 10-year U.S. Treasury note has risen about 35 basis points since December's low, and was last at 4.1397. A large amount of Treasury issuance, expected to nearly double to $2 trillion this year, is also weighing on bond prices.
Rising yields contributed to the dollar's rise against a basket of currencies. The dollar index has risen 2.3% since the beginning of the year, hitting a one-month high after hitting a five-month low in December.
Meanwhile, stock prices continue to rise, but the rate of increase slowed in January. The S&P 500 is up 1.7% this month, following a 4.4% gain in December, driven by gains in big technology and growth stocks, in part due to excitement over the prospects for artificial intelligence.
However, analysts at Deutsche Bank said: “This optimism may be difficult to maintain for long as the good news is priced in and financial conditions remain at an accommodative level.”
(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Anna Driver)
