CPI inflation is at 3.0%, and the Atlanta Fed’s GDPNow estimates a 4Q23 real GDP of 1.2%, in line with the blue-chip consensus. So why are market agents pricing in 125 bps of rate cuts starting next March?
Fed Fund futures are nothing more than another form of economic financialization. If there are economic data points for traders to guess about the future trajectory, the Wall Street product center will design an ETF or derivative to trade that guess – usually in the name of “increasing market liquidity and efficiency.”
Fed fund futures used to act as a signal. Now they’re a part of the great Wall Street casino. Goodhart’s Law applies – “When a measure becomes a target, it ceases to be a good measure.”
Today, the Fed will announce its last monetary policy decision for 2023. We expect no fireworks around the rate decision or the commentary from the Chair. After all, it’s the holiday season. Nobody wants to play the role of Scrooge in the next 18 days.
The risk is that Powell’s rhetoric is more hawkish than the market’s expectation of a 25-basis point rate cut in March. Risk assets, including stocks and credit, are priced for perfection and rate cuts. If they sense rate cuts aren’t coming early next year, it will be hard for stocks and credit to move higher. We think this is a greater risk the closer we get to March. For now, liquidity conditions are supporting financial conditions and helping push stock higher, albeit on weaker volume.
This Friday is the largest option expiration on record, with $3.1 trillion in notional opening interest scheduled to expire or roll into the new year. For context, that represents ~9% of the total market cap of the S&P 500. Financialization of the casino, indeed.
The VIX is at 12. Our analysis suggests it should be closer to the 17-19 range. This extreme has historically been difficult to maintain in the long run, and a return to the historical range would likely signal the next period of equity market weakness, especially for the Magnificent Seven have rallied 71% in 2023, and the rest of the S&P 500 have managed just 6%.
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