Having come so far so quickly, the FOMC is moving forward carefully, as the risks of under- and over-tightening are becoming more balanced…It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease. We are prepared to tighten policy further if it becomes appropriate to do so.
Fed Chair Jerome Powell, December 1, 2023
Investors are increasingly pricing in the start of interest rate cuts in the coming year, while the Fed is lightly pushing back on this view in fear of financial conditions easing too rapidly, as Chair Powell remarked on Friday.
Futures market participants are now attaching a 55.1% probability of a rate cut at the March 2024 FOMC meeting; that’s a considerable change from just one week ago when they were attaching a 21% probability to such a change. What gives? While investors are still in the grip of an immaculate disinflation/soft-landing narrative, we have seen greater evidence of a further weakening of growth over the last few weeks.
Investors have been wrestling with what they believed was a dichotomy between much softer anecdotal economic survey data and what they have seen playing out in the hard data. However, it increasingly looks like the two are starting to converge, with greater weakness in the hard data. For example, the latest Dallas Fed Texas Manufacturing Survey was once again grim reading, with comments such as: “There is nothing encouraging on the horizon”, to “In-coming orders continued to decline over the last six to eight months. Now that we have worked through our backlog, it is affecting our ability to reach breakeven and has affected our employment number. We do not see that this situation will improve into first quarter 2024.” This is coming up against data in the last two weeks that have shown: a 5.4% decline in durable goods orders, a 4.1% fall in existing home sales, a 5.6% fall in new home sales, and the ISM manufacturing index defying expectations of an increase by remaining unchanged at 46.7% (which importantly included a fall in the employment index to 45.8%).
The weakness has also been global with all the major economies experiencing further downward movement in the economic surprises indices (view the pdf report to see the chart). Yet the softening of the U.S. data has been the biggest of these surprises, resulting in a sharp decline in the value of the dollar—falling roughly 3% over the course of November—accompanied by lower bond yields, but higher gold prices.
For equity markets participants, falling rates and a mild economic slowdown are still good news, with the S&P 500 recording its best monthly performance (up 8.92%) since July 2022.