December 27, 2023
Since 2021, the FOMC has steadily revised higher its Fed funds rate forecasts by the end of 2024. This changed last week when the Fed signaled that they now see 2024 interest rates lower than they thought at their September meeting. The consensus is nudging the market narrative towards the Fed and most other central banks cutting rates aggressively in the second half of 2024.
Since the Powell pivot, risk assets have rallied.
Notwithstanding recent bond and stock market exuberance, Fed pivots are generally not good signals for markets. A shift in Fed policy in 1989, 2001, 2008, and 2019 led to lower policy rates and major stock market drawdowns of 15%, 45%, 50%, and 20%, respectively.
We believe three variables will determine if the economy will stick a soft landing in 2024: (i) consumer spending, (ii) corporate earnings, and (iii) financial system stability.
Key Market Indicators for December 2023
- The Bureau of Labor Statistics reported nonfarm payroll additions of 199,000, which was stronger than expected. An estimated 2.6 million new workers entered the labor market year-to-date through November. The U.S. unemployment rate fell to 3.7% from 3.9%.
- The U.S. Treasury yield curve (10-year yield minus the 2-year yield) remains inverted at -45 bps. Typically, yield curve inversion anticipates an economic recession by 12-18 months.
- The Conference Board’s Leading Economic Index reading was -7.6%, its 17th consecutive month of a negative reading.
- The U.S. ISM Services PMI for November was 52.7. A reading above 50 indicates an expansion; the sector has grown in 41 of the last 42 months, with the lone contraction in December 2022.
- The U.S. ISM Manufacturing PMI for November was 46.7, its 13th consecutive month of contraction.
- According to the National Association of Realtors, pending home sales were -6.6% y/y in October, a marked improvement from last December’s -34% y/y. The average 30-year mortgage rate is 7.0%, well below the October 2023 peak of 8.1%. According to the Census Bureau, there was a 3.5 month supply of existing homes and a 9.2 months supply of new homes. The median price of a newly constructed home in the U.S. fell to $409,300 in October, down from a peak of $496,800 (-17.6%).
- The AAII (American Association of Individual Investors) Sentiment Survey reports 53% bullish readings and 21% bearish, for a spread of 32%, a level of optimism last seen in April 2021. This is a contrarian indicator. When retail investors are overly optimistic, below-average market returns typically follow, and above-average market returns can be expected when they are too pessimistic.
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