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A Dovish Fed Pivot

December 19, 2023


The Federal Reserve kept the federal funds rate unchanged at 5.25% - 5.50% at its December policy meeting. However, the Federal Open Market Committee’s (FOMC) updated Summary of Economic Projections (SEP) implied that rate hikes were over and cuts were on the way. The Fed lowered its 2024 year-end federal funds rate forecast to 4.6%, down 50 basis points (bps) from September’s projection of 5.1%. During the press conference, Fed Chair Jerome Powell’s comments added to the risk-on sentiment when he reinforced that Fed officials are now discussing the prospect for cutting rates.


The news reverberated through the fixed income and equity markets. Treasury yields plunged across the curve. The two-year Treasury note, which is most sensitive to monetary policy, fell over 25 bps on Wednesday, while the 10-year Treasury note yield declined 15 bps to just over 4%.


Stocks enjoyed a broad-based rally on the week with several indices hitting new milestones: the Dow Jones Industrial Average broke through 37,000 for the first time and the S&P 500 hit a two-year high. There was also a clear rotation, with sectors that have lagged year to date, such as financials, health care and small caps, participating in the rally.


The futures market has pulled the timing of rate cuts forward and now expects 150 bps of cuts in 2024, beginning in March. This is more dovish than the Fed’s 75 bps of cuts, which could be a source of disconnect for markets moving forward. In fact, New York Fed President John Williams took the opportunity on Friday to suggest a March cut was not likely.


One takeaway from the updated SEP is that a soft landing now appears to be the Fed’s base case. We agree, as our outlook for 2024 is a healthy slowdown and further moderation of inflation. However, we are not as optimistic as the market on the magnitude and timing of cuts. We are forecasting 100 bps of rate cuts, beginning as early as the spring. As a result, investors should enjoy positive single-digit returns across most asset classes in the new year.  


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