Fed still projecting 75bps in rate cuts this year
The major equity indices gained about 1% yesterday, closing at record highs because the Fed did… nothing. They left rates unchanged (as expected) and they’re still planning 75bps in cuts this year (as hoped).
This was welcome news for markets since they’ve only recently come to terms with the Fed’s planned 75bps in cuts this year.
2 months of hotter inflation data saw markets lower 2024 rate cut expectations to match Fed
It’s been a long adjustment process for markets. In mid-January, they were pricing 170bps in cuts this year (chart below). After a series of strong economic readings, they were down to 125bps in cuts by early February.
More recently, though, it’s been hotterinflation – more so than strong labor market or spending data – reducing market rate cut expectations.
We had:
- Two higher-than-expected CPI inflation reports for January and February (with housing and transportation contributing)
- Two higher-than-expected Producer price (PPI) inflation reports for January and February (with hospital services and energy prices contributing)
Still, the Fed has looked past this, recognizing that there’d be “bumps in the road” on the way back to 2% inflation. And markets are now looking for the first rate cut in June.
Treasuries sold off in response to fewer rate cuts being priced in, but equities rallied…
In response to fewer rate cuts being priced in, Treasuries have sold off. 10-year Treasury yields are up 50bps from their lows to 4.3% (left chart below, black line). Equities, however, have kept rising (right chart below, blue line).
Fewer rate cuts should be a headwind for equities since it means borrowing costs stay higher for longer and less of a boost to the economy (and demand) – both of which are bad for earnings. And yet, the Nasdaq-100 and other major equity indices are all at or near record highs.
…because forward earnings keep rising as a soft landing looks more likely
That’s because earnings keep growing as markets see the soft landing as more likely. Nasdaq-100 forward earnings are up 9% since October (chart below, green line), with the economy proving more resilient than expected.
In just the past few days, we’ve seen Goldman up their 2024 GDP growth outlook from 2.1% to 2.4% and the Fed increased theirs from 1.4% to 2.1%, thanks to a strong labor market that supports spending.
So the earnings boost from a soft landing has more than offset any headwind from fewer rate cuts, supporting the equities rally.
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