Evening Brief – 01.23.24
2% or 3%?
By now it’s well-entrenched in market participants’ minds that the Federal Reserve’s target rate for inflation is 2%. While that goal is admirable, we are still in a period (possibly prolonged) of “sticky” pricing pressure, making the central bank’s target seemingly difficult to achieve.
The most recent CPI report for December included components that showed some sectors of the economy are still facing persistently higher costs. To the credit of the market and the consumer, however, some things will most likely remain expensive for some time.
The main message from the report was that while inflation is improving, it has lost some of its downward trajectory – dropping from 9.2% to 3.9% was the easy part. Falling to 2% is where the rubber meets the road. As a result, the Fed is unlikely to cut interest rates as quickly as the market anticipates (wants).
According to the current CME FedWatch Tool, there is a 46.2% probability of the Fed cutting the Fed Funds rate by a quarter-point to 5.00%-5.25% at the March 20 FOMC meeting and a 50% chance of a second quarter-point cut at the May 1 meeting.
One may argue that as we move through 2024, barring a broad-based and prolonged recession, inflation will probably run around 3%-4% on an annual basis, with monetary authorities likely needing to raise their long-term target from 2% to 3%.
The equity markets appear perfectly fine with this possible outcome. The U.S. 10-year Treasury yield has risen from 3.78% to 4.20% in the past month with the Dow Jones Industrial Average, S&P 500 and NASDAQ at new highs.
The idea of a market transition to a phase of slow but steady economic growth that coexists with an acceptable rate of inflation may represent a notable development. If this is indeed the new normal, it suggests a period of stability that both investors and policymakers may need to navigate and adapt to in 2024.
Many investors are buying into this theory, which may explain why the stock market is trading at record highs despite another bout of rising government bond yields.