The markets got the one thing they wanted for Christmas last week - confirmation of a Fed pivot from Powell himself. Stock and bond prices both rallied hard, but I wonder what changed for the central bank over the past couple months. Powell had consistently been talking about the possibility of additional rate hikes and the need for more restrictive policy conditions for longer. Now, the Fed is planning three cuts in 2024. This looks less like a gradual change in thinking and more like a “we may have overdone it and now we need to course correct”. The market, however, has already done a lot of the heavy lifting with the 10-year Treasury yield now down 110 basis points to 3.9% in just 8 weeks. Most of the move in Treasuries so far has been a repricing of duration risk. Let’s see if credit risk enters the equation next.
The market seems to genuinely not be buying what the Fed is selling. The futures market has been pricing in 2024 cuts for some time. Powell came out this past week and says the Fed is planning for 3 rate cuts next year. The futures market immediately priced in 6 cuts for next year. There’s been this disconnect between what the Fed says will happen and what the market thinks the Fed will do for months, but the gap seems as wide as ever. Stocks and bonds seem to be pricing things in as if 6 cuts are coming. Which one proves to be correct remains to be seen, but what if Powell ends up being the one that’s correct. We saw these Fed pivot trades happen multiple times in 2022 where investors got out over their skis, Powell threw cold water on the idea and the markets corrected back to where they were pre-rally. It feels like we’re headed in that direction again.
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