The Fed’s Jerome Powell plays Santa Claus

• The Fed’s comments on inflation sent stocks and bonds soaring.
• Inflation is on the way down: Jerome Powell doesn’t want to wait until 2% to cut.
• Europe’s Central Bank held steady.

It was quite a big central bank week. The December 13 statement from the Federal Open Market Committee (FOMC) and the press conference by U.S. Federal Reserve (the Fed) Chair Jerome Powell certainly caught our attention and that of investors. 

We approached the meeting with the view that across many central banks, policy rates have reached their peak, and this was confirmed.  During his press conference, what caught our attention was when Powell said, “The reason you wouldn’t wait to get to 2% to cut rates is that… it would be too late… you’d want to be reducing restrictions on the economy well before 2%… so you don’t overshoot…” This suggests the Fed may be comfortable with the pace and trend of inflation to start cutting interest rates in 2024. And we would agree. Our belief remains that cuts are more probable starting in the back half of 2024. Still, it is surprising to hear Powell in such a dovish mode.

In response to the FOMC’s stance on inflation, stocks, bonds and gold experienced significant gains, while the U.S. dollar weakened. The small cap Russell 2000 Index led the surge, with regional banks soaring. Additionally, the equal-weighted S&P 500 outperformed the market cap-weighted index. This is largely attributed to the belief that lower rates particularly benefit those companies with weaker balance sheets that need debt refinancing.

The U.S. Federal Reserve adjusted its statement guidance, in expectation of rate cuts next year, cutting its 2024 median positioning more than anticipated. This suggests three rate cuts in 2024, compared to its previous estimate of one and the market expectation of two. During the press conference, Chair Powell hinted at future rate cuts, acknowledging their discussion in the meeting and the likelihood of ongoing rate cut conversations. The money markets have adjusted their expectations accordingly, now anticipating an 88% probability of a 25-basis-point rate cut in March, up from 50% before the FOMC’s recent statement. They foresee 140 basis points of easing through 2024, an increase from the earlier prediction of 115 basis points.

In his press briefing, Powell stated that the Fed considers its policy to be at or near its peak. He also noted that inflation has eased without a significant increase in unemployment. The latest CPI numbers corroborate this, with the headline month-over-month CPI rising by 0.1%, slightly above expectations, and the year-over-year CPI aligning with forecasts at 3.1%, a decline from the previous 3.2%.

In contrast, the European Central Bank’s (ECB) recent meeting was less impactful, with no significant changes. The money market's expectations for ECB rate cuts in 2024 remain stable, pricing in a total of 154 basis points, a slight decrease from the pre-statement 156 basis points. The likelihood of a rate cut in March remains at about 80%.

Listen to this week’s podcast for further insights.