Is The Fed Pivot Finally Here?
Stocks skyrocketed last week as investors digested the latest CPI report and concluded that the Federal Open Market Committee (FOMC) is done hiking interest rates. It's a strong bet investors are making evidenced by the surge in the S&P 500 index which has risen roughly 10% in about two weeks. In previous years, investors would celebrate if the S&P 500 index rose 10% in one calendar year.
As of Friday’s close, the S&P 500 index is up 18% year to date. Assuming the Fed pivot is indeed here, growth stocks, such as the "Magnificent Seven," will continue to rocket higher. These mega-cap tech giants consisting of Alphabet (GOOG , GOOGL), Amazon (AMZN), Apple (AAPL), Meta Platforms (META), Microsoft (MSFT), Nvidia (NVDA) and Tesla (TSLA) will be money-makers for investors who buy today. But when it comes to the Fed's pivot to cutting rates, will they or won’t they? That has been the prevailing question.
The Fed, as it is mandated to do, adjusts the federal funds target rate range in response to what’s happening in the economy. Their two main objectives are to keep prices stable and maximize employment. To achieve this, the Fed adjusts interest rates when economic data suggests the economy starts to overheat, meaning there is too much inflation.
Conversely, the Fed cut rates in weaker periods of the economy when events like high unemployment emerge. In making its policy decisions, the Fed also tracks GDP data, industrial production and, of course, consumer spending. Over the past seventeen months, the Fed has raised interest rates eleven times, moving the fed fund rate by more than five percentage points, from near 0% to 5.5%. This was in an effort to combat the rising costs of living that ravaged household purchasing power.
“Without price stability, the economy does not work for anyone,” Federal Reserve Chair Jerome Powell said at an August 2022 speech at Jackson Hole. “In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all.”
With inflation at multi-decade highs, the Fed did what it could to adhere to its mandates. They had not been this aggressive in its policy decisions in four decades. In the process, stocks got punished due to lack of liquidity, partly because higher interest rates pressured corporate profit margins. In some cases, companies were forced to scale back on growth plans, reduce costs and in come cases execute layoffs.
High interest rates also increase the odds of a recession, which force investors to rethink their appetite for risk, particularly for growth stocks which are often the hardest hit by higher borrowing costs, which pressures their cash flows. Fast-forward to today, the Fed has done a solid job managing inflation which has dropped to 3.7% year-over-year in September, after hitting the highest levels in decades at over 9% in mid-2022.
While the inflation is not yet at the Fed’s 2% target, the October payroll report, along with the recent CPI data, provided strong arguments for no further rate hikes. This means the Fed's July rate increase was likely the last one. In fact, the Fed has held rates steady three times in its last four policy meetings. In my view, the Fed is done raising interest rates. We won’t know this for certain until its actions say so because, the Fed — which often reminds us they are “data dependent” — won’t explicitly state they are done.
They want to preserve the option to raise rates in the future if inflation reaccelerates. Still, the big debate now is when a rate cut will happen. My guess is there will be at least one rate cut in the first quarter of 2024. It’s not hard to imagine for three more cuts to follow by the end of the 2024, affirming the arrival of the long-awaited Fed pivot.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.