The Fed's "dovish" voice makes the market happy, can the market go further at the end of the year?
U.S. stocks achieved five consecutive weekly gains, and the Dow and S&P 500 refreshed new highs for the year.
While Fed Chair Jerome Powell reiterated that it was too early to talk about a rate cut and medium- to long-term Treasury yields continued to be under pressure, fund flows showed signs of profit-taking among investors and a slowdown in tech stocks. In the coming week, the non-farm payrolls data will be in focus, and the softening of the labor market is very critical to inflation and the policy path, which may be an important watershed in the subsequent space of this round of rebound.
The Fed prepares to end the rate hike cycle
Last week, the US released a blockbuster inflation report, which was one of the few key indicators before the Fed's decision. The data showed that the US personal consumption expenditures price index (PCE) growth in October fell further to 3.0% from the previous 3.4%, hitting a new low since February 2021. Core PCE growth excluding energy and food also slowed to 3.5% from 3.7% in September.
At the same time, signs of a gradual cooling of the economy continue to emerge. The U.S. manufacturing recovery stalled, with the S&P Global November manufacturing PMI and the ISM manufacturing index remaining in contraction territory. The labor market has cooled, with jobless claims continuing to hit their highest level in nearly two years last week, suggesting that it has become more difficult for job seekers to find work. These dovetail with the recent situation expressed in the Fed's Beige Book, which is that the economy is slowing, labor demand continues to ease, and price increases are slowing.
Bob Schwartz, a senior economist at Oxford Economics, said in an interview with CBN reporters that inflation in the United States is losing momentum, and "there are more signs that inflation in the core services sector, excluding housing, is slowing down, while housing inflation has been high." This is the key, and the future decline in price pressures is inseparable from the decline in rent costs, as well as a further balance between supply and demand for employment. He believes that the prospect of a soft landing for the US economy is increasingly becoming a reality.
The latest comments from Fed officials shed light on the divergent positions within the committee. Fed Chair Jerome Powell said in his latest speech that policy risks have become more balanced, but it is too early to declare the end of the fight on inflation, reiterating a cautious stance. His views are similar to those of the Fed's "No. 3" and New York Fed President Williams. The latter believes that it is now at or near the peak of the target range for the federal funds rate. From this point of view, the current mainstream view within the Fed is still to keep interest rates unchanged.
In contrast, there are also two views within the Fed: raising and cutting interest rates. Fed Governor Bowman hinted that more rate hikes may be needed to fight inflation. Another Fed governor, Waller, unexpectedly became the first member to relax on his accommodative stance, arguing that the current policy would be effective in slowing economic growth and bringing inflation back to 2%, so there was no reason to keep interest rates high.
Fed funds rate futures show that while betting on the Fed to end its rate hikes, the node of the first rate cut has been brought forward to May next year, and there is room for at least four rate cuts throughout the year. It is worth mentioning that the ING released a report predicting that if the US economy shows obvious signs of slowdown, it means that the Fed may cut interest rates six times.
The U.S. Treasury market extended its rally, with the 2-year Treasury note, which is closely correlated with interest rate expectations, plunging nearly 40 basis points in a single week, the biggest drop since March this year, and the benchmark 10-year Treasury note falling to the 4.20% mark, the lowest since September. Ian Lyngen, a strategist at BMO Capital Markets, said in the report that the rebound in U.S. Treasuries not only reflects the Fed's progress in rebuilding price stability and rebalancing the labor market, but also reflects that the current cycle of rate hikes is likely to be over. "Investors were quick to start discussing the timing of the Fed's first rate cut. ”
Schwartz told CBN that he agrees that the Fed has ended its rate hike cycle. But contrary to the outside view, he felt that the market's hopes for a rate cut were too optimistic. With inflation still above target and the economy not sending red flags, the Fed will not rush to cut interest rates. Schwartz expects the Fed to consider cutting interest rates only if core PCE falls to around 2.5%, which may have to wait until the third quarter of next year.
How the market behaved at the end of the year
Over the past week, U.S. stocks have extended their rally since late October, and investors' risk appetite continues to be boosted by the possibility that the Federal Reserve will end its rate hikes and cut rates earlier.
However, there are signs of divergence. The Nasdaq and S&P 500, which had previously performed well, showed a trend of consolidating at high levels, and the momentum of star technology stocks weakened. Some observers are concerned that the recent over-optimism in the bond market has left the market vulnerable to a pullback. Ipek Ozkardeskaya, senior analyst at Swissquote Bank, said: "At current levels, US bonds are approaching an overbought market, and the dollar has entered oversold territory... Indicators across most asset classes are warning that a correction may only be a matter of time. ”
The good news is that cyclical sectors have gained momentum, with the Dow breaking through 36,000 points for the first time since January 2022, and the small-cap index Russell 2000 also performing well. Adam Turnquist, chief technical strategist at LPL Financial, said that after the short-term rally, overbought technical indicators made bears eager to take a try. If the market stays at the current level for longer, the less selling pressure is likely to be on the indicator after it has been repaired.
The flow of funds shows that some investors are showing a willingness to take profits. The London Stock Exchange (LSEG) found that the net outflow of U.S. equity funds reached $3.31 billion last week, the first net redemption of funds since November, with the net outflow of the technology sector reaching $2.19 billion. At the same time, U.S. money market funds received $68.28 billion in inflows, the highest since March this year.
Charles Schwab wrote in its market outlook report that the past week has been a consolidation phase of the rally, with investors showing early signs of rotation to small-cap and value stocks. The catalyst for the decline in US Treasury yields appears to be Powell's latest comments, and although he did not convey any new information, investors seem to be focusing their attention on the statement that monetary policy is "in the restrictive zone".
According to the report, the S&P 500 is hovering below the resistance of 4,600 points, and it remains to be seen whether it will be able to break through this level in the future. The focus of the market will turn to the data, what will happen to the market if the NFP report is stronger than expected? Last month, the stock market responded positively to the weak NFP report, so investors obviously want to see lower-than-expected numbers, especially wage growth.