The recent 4.6% pullback in the S&P 500 is not due to geopolitical tension but rather reflects changing expectations around monetary policy. Atypical flight-to-safety characteristics are observed in rates, the dollar, yen, and oil. Tightening financial conditions indicate a correction of the market's previous errors, with the Fed signaling fewer rate cuts in 2024. The market's rally was driven by easing financial conditions and multiple expansion, not improved earnings outlook, and as conditions tighten, the PE ratio of the S&P 500 is expected to contract. This correction may signify the beginning of a more significant downturn as the market corrects its previous mistakes.
The US dollar is expected to strengthen against the euro and other major currency pairs due to diverging paths between the Fed and ECB, leading to tighter financial conditions and impacting multinational companies' earnings. Widening spreads between central banks and rising interest rates could drive the euro lower and affect other currency pairs. This may result in a contraction of the S&P 500's PE ratio and impact equity valuations, potentially leading to a much lower path for the index.
The March CPI report is expected to show another increase in inflation, with analysts predicting a rise in both headline and core CPI. The market is not expecting any surprises and anticipates an in-line number. Rising inflation expectations have led to a reevaluation of rate cut projections, with fewer rate cuts now being priced in. This could lead to a stronger dollar and better financial conditions, as the market adjusts Treasury yield curve rates in response to the hot inflation reading.
The stock market is facing potential headwinds as financial conditions tighten and liquidity is drained from the system, leading to a possible contraction in S&P 500 multiples. Rising Treasury rates and widening credit spreads may result in the S&P 500 falling within a range of 3,800 to 4,100 over the coming year. The unwinding of the Bank Term Funding Program and quantitative tightening by the Fed are contributing to the decline in reserve balances and liquidity. As financial conditions tighten, equity valuations may decrease, impacting stock prices.
Atlanta Fed President Raphael Bostic warns of a "new upside risk" in the form of "pent-up exuberance," where businesses, eager to capitalize on potential interest rate cuts, could unleash a surge in hiring and investment, leading to upward pressure on prices and reigniting inflation. This phenomenon has already been observed, with financial conditions loosening and employment surging. Bostic cautions that the fight against inflation is not over, and the Fed's rate-cut mania may have inadvertently exacerbated the situation, making the inflation fight harder and longer.
The Federal Reserve Bank of New York's January 2024 Survey of Consumer Expectations reveals improved perceptions and expectations of financial conditions and credit availability among households, with unchanged inflation expectations, mixed labor market expectations, and increased optimism about future credit access. Median expected household income growth and perceptions of credit access have increased, while the mean perceived probability of job loss has decreased. The survey also indicates improved perceptions about households' current financial situations and expectations for the future.
Federal Reserve Governor Waller gave a speech discussing the economic outlook, noting that economic activity has moderated, unemployment remains low, and inflation is close to the 2 percent target. He expressed confidence in the economy's trajectory but emphasized the need for cautious policy changes. Waller suggested that the Federal Open Market Committee may consider cutting the policy rate in 2024, depending on sustained progress in inflation and labor market conditions. He also highlighted the importance of data analysis in informing policy decisions and stressed the need for methodical and careful rate adjustments when the time is right.
The upcoming Federal Reserve meeting will address the possibility of rate cuts and the extent of rate cuts in 2024. While investors are already pricing in rate cuts for next year, the Fed may provide a surprise by raising its estimate of the long-term neutral interest rate, potentially impacting the 10-year Treasury yield. The Fed wants to avoid excessive easing of financial conditions and a potential stock market rally, which could lead to a sharper economic slowdown.
As the Federal Reserve prepares to meet, some are advocating for "adjustment cuts" to offset the decline in inflation. However, the article argues that financial conditions are already loosening, making such cuts unnecessary and potentially risky.
The recent rally in the stock market has led to looser financial conditions in the U.S., erasing two months of Federal Reserve tightening. The drop in 10-year Treasury yields and surge in equity prices have reversed the tightening in conditions seen since September. This puts the Fed in a difficult spot ahead of its upcoming policy meeting, as it aims to keep credit restrictive until inflation is under control. The Fed is not expected to raise rates next week but may choose to keep rates high for longer, potentially delaying the first rate cut until September 2024.
Tom Lee, head of research at Fundstrat, has given the highest 2024 forecast for the S&P 500 yet, projecting the benchmark index to reach 5,200 by the end of the year. Lee believes that falling inflation and easing financial conditions will support the US economy and prevent a recession. His target surpasses other strategists' predictions and is based on market breadth, with a focus on small caps, financials, and real estate. Lee remains bullish on the tech sector and expects it to outperform the broader market. He also sees potential for further rate cuts from the Federal Reserve, which could benefit small caps, financials, and real estate. The risk of a recession is not seen as a major threat, as it could lead to more rate cuts by the Fed.
Financial conditions eased at the fastest pace in four decades in November, raising concerns about the Federal Reserve's ability to cut interest rates as quickly as expected. The easing was driven by soaring stocks, falling Treasury yields, sliding crude-oil prices, a weaker U.S. dollar, and tighter credit spreads. While historically easing financial conditions have been positive for markets, some worry that if conditions continue to ease, it could lead to higher inflation. The Fed has not shown concern about the recent easing, but if conditions ease too much, they could push back against expectations for rate cuts, causing yields to rise, stocks to fall, and the U.S. dollar to strengthen.
The US GDP figure is expected to influence the sentiment of the day, with the S&P 500 and Nasdaq outlook dependent on whether the figure leads to a corrective phase or a continuation of the upward trend. The bond market is already anticipating rate cuts, with corporate bonds performing well and financial conditions easing.
Asian markets are expected to start the week strong following Wall Street's rally on Friday. China will be in the spotlight with a U.S.-Sino Presidential meeting, top-tier economic data, and corporate earnings releases. Financial conditions are easing, particularly in Japan, where conditions are the loosest in almost 34 years. However, economic activity in Japan is not meeting expectations. The Chinese news flow this week is significant, with a face-to-face meeting between U.S. President Joe Biden and Chinese President Xi Jinping, as well as key economic data releases and earnings reports from major Chinese companies. Chinese equities have seen modest gains but have yet to recover losses from October.
Asian markets are expected to start the week with a strong rally following Wall Street's surge on Friday. China will be in the spotlight with a U.S.-Sino Presidential meeting, a slew of economic data releases, and corporate earnings reports from major companies such as JD.com, Tencent Holdings, Alibaba Group, and Lenovo. Financial conditions in Japan are at their loosest in almost 34 years, but economic activity is not meeting expectations. Other highlights this week include preliminary Japanese GDP, Indian inflation, and a policy decision from the Philippine central bank.
