Our View: FOMC Still Dovish, Base Case Unchanged
Our Views
- The Fed forecast included expectations of higher growth, lower unemployment, and higher core inflation. These all basically say that the Fed should be incrementally hawkish, but instead they’re still anticipating three cuts. To me, that’s a dovish Fed, and I think we saw that in evidence during the Q&A when Powell pushed back on the suggestion that January and February CPI showed a change to the declining trend of inflation.
- Once the market begins to see the Fed as dovish, a lot of things can happen. These include easing financial conditions, market expansion, breadth expansion, improved consumer confidence, improved CEO confidence, and falling interest and mortgage rates. In our view, these are all good for stocks.
- Bottom line: After this FOMC, we would stick with what’s been working so far this year: AI, Ozempic-related, Financials and Industrials, Bitcoin and proxies, and small caps.
- Three cuts have already been baked into market prices, so for investors this wasn’t an unusual change of policy.
- When looking at the Fed’s comments, we saw expectations for higher GDP, higher core inflation, and lower unemployment, yet the dot plot remained unchanged. So despite this data appearing to paint a robust picture, it seems to me that the Fed and Powell are still erring on the side of dovishness.
- On a tangential note, I would note that this is something Powell has in common with [Kazuo] Ueda [Governor of the Bank of Japan].
- That is both interesting and certainly very supportive for risk assets in the short run. We saw both bonds and stocks react positively Wednesday afternoon, and now the dollar is starting to drop.
- Strictly from a political perspective, we are at the beginning of particularly precarious time for the Fed because, as the election draws closer, they don’t want to be accused of putting their thumb on the scale for one candidate or another. And I think that in addition to all of the economic concerns, Jay [Powell] is very aware of that.
- In view of that, my non-economic opinion is that June is the latest that the FOMC could begin to cut rates, because if they do it any closer to the election, they’ll be accused of making a politically influenced decision.
After a series of data releases in late 2023 that showed inflation retreating, investors greeted 2024 constructively, apparently anticipating that the Federal Reserve was on the verge of cutting rates aggressively. In early January, Fed funds futures trading implied that the market was expecting as many as seven rate cuts in 2024. Of course, that was before two CPI readings came in hotter than expected, softening the ebullience that had characterized the markets
Fundstrat Head of Research Tom Lee saw both CPI prints as aberrations, citing seasonality and potential methodology-related reasons for their deviation from trend. Lee reminded clients that inflation was continuing to tank, while also arguing that Fed economists would not use one – or two – months of unexpected inflation readings to change the course that the central bank had already signaled in previous meetings.
Fed officials strove to communicate a similar message. For example, during a speech in the Council on Foreign Relations after January CPI was released, Chicago Fed President Austan Goolsbee said that despite the hotter-than-expected numbers, “It's totally clear that inflation is coming down,” telling his audience not to get “amped up when you get one month of CPI that was higher than you expected it to be.” (It’s worth noting that due to regularly scheduled rotation, Goolsbee is not currently on the FOMC and thus did not vote on Wednesday’s decision.)
With this as a backdrop, Lee saw markets as apprehensive this week ahead of the FOMC meeting, citing weakness in small-caps and bitcoin as examples of such nervousness. Yet Lee expressed confidence that the market would rally and recover after the meeting. He based his view on:
- History. Seven times during this rate-hike cycle, markets have been soft heading into an FOMC meeting. A rally followed the meeting on four of those occasions. In addition, of 17 FOMC meetings since 2022, stocks have gained in the 10-day period after the meeting 71% of the time.
- Market expectations. Investors had already priced in “bad news” ahead of the meeting, expecting fewer and later cuts.
- Dovish Fed stance. Lee singled out Fed Chair Jerome Powell’s biannual testimony before Congress on February 28, when he noted that “we’re not far from” a scenario in which the Fed would be comfortable beginning to cut.
As he saw it, ongoing skepticism about equities in general and about expectations for a hawkish Fed could also fuel a post-meeting rally.
Head of Technical Strategy Mark Newton agreed, noting, “I’m inclined to agree with Tom that Powell could be more dovish, ignoring the last two CPI reports which looked to be influenced by seasonality factors.” From Newton’s technical perspective, he also noted that “it's thought that interest rates, along with the US Dollar, could be on the verge of peaking, and this might take place post-FOMC when the Fed sheds some light on its terminal rate and dot plot projection.”
Indeed, with the FOMC again leaving rates unchanged at 5.25%-5.5% as widely expected, investors and market observers zeroed in on the Summary Economic Projections (SEP) and the dot plot. FOMC members as a whole continue to expect three rate cuts in 2024.
The result?
US 10-year yields spiked to around 4.32% at 2:34 p.m., as Powell began his press conference, then plunged to close the day at 4.27%, as Newton suspected would happen. Furthermore, stocks rallied, with the S&P 500 setting a new record high and closing above 5,200 for the first time.
