By Rob Foss
Chief Investment Officer
EdgeRock Wealth Management

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The Federal Reserve Board of Governors met this week in Washington DC for the final time in 2023. Afterward Chairman Jerome Powell addressed the media to share the board’s policy decisions.

No one was surprised to learn the FED would hold its target rate at 5.25-5.5 percent. Inflation continues to trend downward toward the central bank’s preferred rate of two percent. It’s clear they believe current policy is adequate for addressing the current condition of the economy. What caught market participants off-guard was the FED’s 2024 outlook, which included three rate cuts next year.

This confirms what fixed-income investors have been betting on now for several months. In fact, the Federal Funds Futures market is now pricing in a 98-percent probability the FED will cut its target rate by 25 basis points in March. This sparked a dramatic rally for risk assets in the days that followed.

What should this news tell us? Well, probably nothing definitive. (Yet.)

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Reasons to be optimistic

• For better or worse, market rallies are great! I’ve never met a professional investor who doesn’t welcome them to a certain degree. (Unless they’re too busy trying to cover all their short/bearish bets, of course.) 
• Financial markets are a leading indicator. So increased breadth (i.e. more stocks moving upward at the same time), as seen by the massive participation of small capitalization stocks, for example, is a good sign of sustainable, positive momentum.   
• The consumer is still resilient. Spending increased by 0.3 percent month-over-month and over four percent year-over-year. This is important because consumer spending is still the most significant component of GDP. Also helping the consumer is the labor market is still generally strong. A strong consumer will only contribute to achieving a soft landing. If this scenario comes true, in combination with projected double-digit earnings growth for the S&P 500 for next year, 2024 could be a great year for domestic financial markets.

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Reasons for caution 

• A common refrain here at EdgeRock is the future is unknowable. The probability of a soft landing most likely increased this week, but is far from a certain outcome. We still think it makes sense to consider other, less optimistic scenarios when designing and implementing client allocations.
• What about quantitative tightening (QT)? While the FED’s target rate is front-and-center, the balance sheet run-off is still happening. The effects of monetary policy are long and variable, and in combination rate hikes (read: slowing real estate markets), we still don’t know how the balance sheet run-off will affect the economy and, in the end, the consumer.  

 

• While market rallies are overall a welcome event, there is always a risk of chasing markets that turn out to be disastrous. After a very tough third quarter, markets have seemingly done nothing but move upward. The result right now is that markets are in a very overbought position, as determined by various technical indicators, which will not last forever. While not a prediction, we would not be surprised if the rally cooled a bit.