Fed’s Strategy in the December FOMC Meeting Amidst Divergent Market Expectations
As the year draws to a close, all eyes are on the impending December FOMC meeting—the culmination of major US economic events. Expected to be the final act of the rate-hike cycle, this meeting sparks curiosity about the Fed’s stance on potential rate cuts in 2024 and how it aligns with market expectations.
This week’s FOMC meeting is a pivotal moment, marking the potential conclusion of the rate-hike cycle in 2023. As we approach Wednesday’s outcome, the likelihood of no rate moves is almost certain. The focus, however, shifts to the Federal Reserve’s strategy in countering market expectations for the first rate cut in 2024 and total cuts throughout the year.
Market sentiments are divided, with nearly a 50-50 split on an initial reduction in the federal-funds rate by March, and a high certainty of a cut by May. Contrarily, I remain sceptical, projecting the Fed to maintain its target range at 5.25%-5.50% until July. Fed speakers, including Chair Powell, have consistently deemed it “premature” to discuss or consider rate cuts, emphasizing the ongoing progress in addressing inflation and balancing the economy’s supply and demand.
Despite recent indicators suggesting a softening in both price pressures and economic activity, I interpret this as an anticipated economic cool-down rather than a catalyst for immediate rate cuts. While rate-cut expectations dipped after robust nonfarm payrolls data last Friday, the market still holds a more dovish stance than my outlook, creating a notable disparity.
The upcoming December Summary of Economic Projections, often referred to as “the dots,” will play a crucial role in the Fed’s attempt to signal its stance. The September dots predicted an additional hike in 2023 (yet to materialize) and a year-end 2024 level of 5.1%, in contrast to the current federal-funds futures-implied interest rate for Dec24 at 4.2%. While I anticipate the December dots to surpass current market expectations, questions linger about the end-2024 dot and the extent of divergence among officials’ submissions.
Chair Powell’s post-meeting press conference adds another layer to the market dynamics. Historically nonchalant about the market-Fed disparity, Powell’s dismissive stance may persist. If so, it might do little to alter market pricing, setting the stage for an intellectual battle between the Fed and the market in the early days of 2024.
The data-centric approach and the Fed’s commitment to being data-dependent suggest that each major economic release in early 2024 will serve as a referendum on the federal-funds rate path. This has already led to significant market volatility in recent weeks, driven by swings in both Fed expectations and rates across the curve.
This anticipated data-induced volatility coincides with a bond market already grappling with increased coupon supply, intra-day price swings, and challenging liquidity. The MOVE index of fixed income volatility and a US Treasury liquidity index illustrate persistently elevated volatility and liquidity challenges since mid-2021.
In summary, a relatively hawkish December FOMC meeting looms against a backdrop of a dovish market outlook and the anticipated conclusion of the rate-hike cycle. The critical question remains: Will the markets heed the signals from the dots and the press conference? If not, the dawn of 2024 may witness a stark divide between the Fed and investors, ushering in a volatile start to the year.
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