Stock investors have gotten off to a wobbly start to the new year, hobbled by shifting expectations on the timing and extent of Federal Reserve interest-rate cuts in 2024.
All three major U.S. stock indexes snapped a nine-week winning streak on Friday, after unexpectedly strong December job gains prompted traders to briefly pull back on the chances of a March rate cut. The $S&P 500 Index(.SPX.US)$ and $Nasdaq Composite Index(.IXIC.US)$ also failed to stage a Santa Claus Rally from the five final trading days of 2023 through the first two sessions of 2024, as questions grew about the market’s multiple rate-cuts view.
It all adds up to a glimpse of what might be in store for investors in the year ahead. Already, the so-called “January effect,” or theory that stocks tend to rise by more now than any other month, could be put to the test by headwinds that include stalling progress on inflation. Inflation’s downward trend in recent months had given traders and investors hope that as many as six or seven quarter-percentage-point rate cuts from the Federal Reserve could be delivered in 2024, starting in March.
Over the first handful of days in the new year, however, reality has started to sink in. For one thing, multiple rate cuts tend to be more commonly associated with recessions and not soft landings for the economy.
Moreover, the idea that the Fed could follow through with as many rate cuts as envisioned by traders would significantly increase the probability that policymakers lose their battle against inflation, according to Mike Sanders, head of fixed income at Wisconsin-based Madison Investments, which manages $23 billion in assets. That’s because six or more rate cuts would loosen financial conditions by too much, and boost the risk of another bout of inflation that forces officials to hike again, he said.
Minutes of the Fed’s Dec. 12-13 meeting show that policymakers were uncertain about their forecasts for rate cuts this year and failed to rule out the possibility of further rate hikes. Nonetheless, fed funds futures traders continued to cling to expectations for a big decline in borrowing costs, with the greatest likelihood now coalescing around five or six quarter-point rate cuts that total 125 or 150 basis points of easing by year-end. That’s roughly twice as much as what policymakers penciled in last month, when they voted to keep interest rates at a 22-year high of 5.25% to 5.5%.
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