Investors cheered several economic data releases last week that continue to support the idea that the Federal Reserve is done hiking rates. With the figures showing price increases ebbing, the labor market slowing, and real consumer spending tightening, optimistic investors have priced in the fabled soft landing and expect the Federal Reserve to begin rate cuts as early as March 2024. For now, it appears the Fed has struck the right balance as calls for recession wane; however, there are several dynamics that present a risk to the market rally, notwithstanding geopolitical, fiscal, and consumer-related developments. US markets moved higher last week following the reports. Equities climbed +2.3% driven by rate-sensitive, value sectors and fixed income advanced +1.4% as rates fell across the yield curve. Of note, the biggest gains came from the Russell 2000 Index as small caps bounced +5.5%.
The inflation print on Tuesday showed price increases slowed significantly in October, with the month-over-month number coming in flat (vs +0.1% expected). The headline CPI number benefited from cheaper oil and gasoline prices. The core CPI measure, which excludes volatile food and energy costs, increased just +0.2% from September, also coming in below expectations. Additionally, year-over-year CPI figures came in lower – headline CPI showed a +3.2% increase while the core measure hit +4.0%, the lowest level since September 2021. Economists generally favor the core gauge (or a super core measure as designated by the Fed) as a better indicator of underlying inflation. Substantiating the CPI report, month-over-month producer prices (PPI) fell by -0.5% – the largest drop since April 2020 and helped by decreasing energy costs. The recent data supports the narrative that the Federal Reserve is done with rate hikes with the conversation moving to when markets can expect rate cuts.
Is the Federal Reserve going to bring the economy in for a soft landing? The Fed must weigh the consequences on each side – cut rates too soon and risk inflation re-accelerating versus hold rates too high for too long and risk a recession. So far, the data suggests the Fed has capably guided the markets over the past couple years to a lower growth, lower inflation environment without materially damaging the labor market. There are still several economic data points to be released ahead of the December Fed meeting, but the trend towards stable prices and full employment is shaping up nicely. As such, market strategists across Wall Street have been increasing their calls for rate cuts early in 2024. While consensus suggests the Fed will cut three times over the next 12 months as seen in the chart below, UBS is predicting seven cuts, Morgan Stanley suggests four to five cuts, and Morningstar sees four cuts. Of note, Goldman Sachs and JPMorgan see rate cuts largely in line with market expectations.
Retail spending came in above expectations for October but still showed consumers took a break ahead of the holidays. The retail sales gauge showed a decline of -0.1%, ahead of expectations of -0.3%. Real retail sales (including inflation) fell into negative territory for the first time in six months pointing to a gradual slowing for the broader economy. Control group sales — used to calculate gross domestic product — increased +0.2% after the previous month was revised higher to +0.7%. This suggests that broad economic momentum remains positive leading into Q4, albeit slowing relative to previous periods. The resilience of the US consumer, the largest contributor to domestic GDP, has continuously surprised economists and has held off recession expectations. Through the lens of the Federal Reserve and investors more broadly, this was taken as a positive development.
Source: Bloomberg, Bureau of Labor Statistics, US Commerce Department
– Written by Eric Schmitz, CFA