Stocks are facing a key three-day stretch this week as investors look to Wednesday’s Federal Reserve policy meeting to clarify the central bank’s 2024 rate path and potentially extend one of the strongest Wall Street rallies of the past five years.
A host of factors have underpinned the market’s third-quarter surge, which has lifted the S&P 500 nearly 12% from its late-October nadir. It’s put the broadest measure of U.S. shares within 200 points, or just under 5%, of the all-time high it reached in January.
Better-than-expected earnings, a resilient labor market, easing inflation prospects and the tech-powering impact of artificial intelligence have combined to boost domestic stocks. The S&P 500 is riding a six-week winning streak and the Nasdaq is looking at its best nonpandemic-year gain since 2009.
Related: Analyst’s surprising S&P 500 prediction doesn’t depend on Fed rate cut
However, bets that the Fed has reached the end of its interest-rate-hiking cycle — the most aggressive in four decades — and the historic rally that’s trigged in U.S. Treasury bonds have likely been the most powerful driver of U.S. stock market gains.
And that makes this week’s front-loaded series of bond auctions and inflation data so crucial to the market’s chances of making a run at a record.
The Treasury will look to raise around $330 billion over the next two days, in the form of three short-term bill auctions and three coupon bond sales. These include $37 billion in 10-year paper today and $21 billion in a new year offering tomorrow — just hours after the November inflation report.
That’s a staggering amount of debt for the market to absorb in such a short time frame, and in early Monday dealing, Treasury markets are starting to reflect the strain.
Federal Reserve Chairman Jerome Powell.
Benchmark 10-year-note yields, which ended last week at around 4.23% following the stronger-than-expected November jobs report, were last marked 4 basis points (0.04 percentage point) higher at 4.279% ahead of today’s auction.
At the same time, 2-year note yields, which surged 13 basis points on Friday, added another 6 basis points to change hands at 2.765%. That move reflects both the impending increase in supply and traders paring bets that the Fed will cut rates in the spring.
The odds of a March decrease, in fact, fell to 38.4% following Friday’s jobs report, which included a drop in the headline unemployment rate and a faster-than-expected reading for monthly wage gains of 0.4%.
Related: Jobs report surprise shows solid November hires as unemployment eases to 3.7%
Markets are still expecting the Fed to lower its benchmark lending rate by a 0.25 percentage point, to between 5% and 5.25%, when it meets in May. But they’re now beginning to reconsider their forecast of five cuts for the year as the economy avoids recession.
“We expect to see another interest rate pause from the Federal Reserve on Wednesday, which would be an acknowledgement that inflation is coming down,” said Greg Marcus, managing director for UBS Private Wealth Management in Washington.
“While the market is pricing in rate cuts in 2024, we expect the Fed to downplay the possibility of rate cuts in its commentary,” he added.
The November inflation report, however, could add an extra degree of complexity to that equation. An 8% slide in gasoline prices is pulling the headline rate closer to 3%, the lowest since June and within a percentage point of the Fed’s preferred target of 2%.
Core consumer prices, however, are likely to nudge higher on the month, and stick at a rate of 4% on the year. That would provide enough ammunition for the Fed to pour cold water on rate-cut bets and buttress its near-term growth and inflation forecasts.
(Those forecasts are based on the Fed’s so-called dot plot, the estimates from each of the members of the central bank’s policy panel.)
Related: Recession is a long way off, and that means Fed rate cuts may be as well
“Central banks have fought to significantly tighten the economy amid a dangerously high wave of inflation, and they will only move once they have the certainty of having fixed this problem,” said Althea Spinozzi, senior fixed-income strategist at Saxo Bank.
“Otherwise, they risk entering stagflation, a period of high inflation and high unemployment, which is a much more challenging scenario to deal with, especially during an election year,” she added.
Jeffrey Buchbinder, chief equity strategist for LPL Financial in Boston, says investors should welcome any delay in Fed rate cuts, given that stocks have historically underperformed in the six months that follow the first easing move.
“While average gains don’t look great (2% over the subsequent six months and [5% to 6%] over the next 12), they aren’t bad either,” he said.
“The dispersion is where this gets more interesting. During challenging economic environments such as the early 1980s, early 2000s, and pre-Great Financial Crisis, stocks suffered mightily after the Fed easing cycle began.”
Action Alerts PLUS offers expert portfolio guidance to help you make informed investing decisions. Sign up now.
