The rally that’s driving global bonds to their best month since 2008 gained further traction, with Treasuries climbing on bets the Federal Reserve will be able to start cutting rates in the first half of 2024.
Hopes for a Fed pivot intensified after economic data emboldened the so-called Goldilocks scenario. Two-year yields dropped nine basis points to 4.65%.
Fed swaps priced in a quarter-point rate cut by May. The S&P 500 wavered near “overbought” levels.
Nvidia Corp. led gains in chipmakers, Tesla Inc. whipsawed in the run-up to its Cybertruck event and Microsoft Corp. fell.
Oil climbed ahead of a high-stakes OPEC+ meeting.
Gross domestic product rose at the fastest pace in nearly two years, while consumer spending advanced at a less-robust rate.
The Fed’s preferred inflation metric – the personal consumption expenditures price index – was revised lower. US economic activity slowed in recent weeks as consumers pulled back on discretionary spending, the Fed said in its “Beige Book.”
“The anecdotal evidence suggests the Fed is getting what it wished for – an economy experiencing a painless, measured slowdown,” said Jeffrey Roach at LPL Financial.
“As pricing pressures will likely ease further in months ahead, markets can reasonably expect the Fed to pause until the middle of next year – when the Fed could modestly cut rates.”
Bonds extended their powerful November rally on speculation the Fed is done with its aggressive hiking cycle.
A Bloomberg gauge of global sovereign and corporate debt has returned about 5% this month, heading for its best performance since the depths of the recession in December 2008 – when the Fed cut rates to as low as zero and pledged to boost lending to the financial sector following the collapse of Lehman Brothers Holdings Inc.
“If more start to believe the Fed is done and focus on the next rate moves – which will be cuts – then there is plenty of firepower to bring rates lower in yield,” said Andrew Brenner at NatAlliance Securities.
“However, we have moved a lot in a short period of time.”
Traders are now gearing up for the release of the Fed’s preferred measure of underlying inflation on Thursday - seen by many as the most-important economic report this week.
“No single month should influence Fed decision-making,” said Jim Solloway at SEI.
“But a weak result, along with a further increase in the unemployment rate above the 4% mark, would certainly sway the committee to lean toward the dovish side. Our best guess, however, is that the Fed keeps its policy rate at its current level through the first half of the year. We don’t expect the Fed to cut rates as aggressively in 2024 as markets have recently priced in.”
Fed Bank of Cleveland President Loretta Mester signaled she would support continuing to hold rates steady at the December meeting, saying policy is “in a good place” to assess whether inflation is on a path back to 2%.
Atlanta Fed chief Raphael Bostic said he’s growing increasingly confident that inflation is firmly on a downward trajectory, while his Richmond counterpart Thomas Barkin told CNBC the central bank should keep the option to hike.
The U.S. economy is “fine,” said Neil Dutta, economist at Renaissance Macro Research.
“For equity market investors, this is soft-landing nirvana. For bond investors, I’d expect a continued bull steepening of the yield curve.”
Multiple block trades supported a steepening of the US curve Wednesday – with yields on short-dated Treasuries falling more than those on longer securities.
Such trades are set to benefit as the U.S. moves closer to rate cuts.
To John Leiper at Titan Asset Management, while GDP highlighted the strength of the economy, the drop in the core PCE price index will be interpreted by Fed officials as a sign their strategy remains on track and they may achieve a soft landing scenario. “The Goldilocks narrative continues for now,” he said.
“The Fed could find themselves in a ‘sweet spot’,” LPL’s Roach added. “Inflation is trending lower, the consumer is still spending – but at a slower pace – and the Fed could end its rate hiking campaign without much pain inflicted on the economy.”
While Wall Street is betting rate cuts will finally bring about the end of the Fed’s so-called quantitative tightening, Bank of America Corp. strategists say it’s the banking system’s demand for a larger cash buffer that could end QT by the latter half of next year, if not sooner.
When the central bank’s overnight reverse repurchase agreement facility – considered an indicator of excess liquidity – drains to zero, that will force the Fed to end its runoff, they said.
Stock traders have become more enamored rate-cut prospects without fully considering the “why,” according to Steve Sosnick at Interactive Brokers.
“If we do get a soft landing, why would the Fed be willing to cut as early as May?, Sosnick noted.
“I have no reason to doubt that the Fed would be quick to cut rates or back off QT if economic circumstances dictate. But those circumstances are not what is priced into the market right now. Be careful what you wish for.”
Jamie Cox at Harris Financial Group says that even as the headline GDP numbers were revised higher and look rosy, it is concerning that consumer spending is starting to roll over.
Billionaire investor Bill Ackman is betting the Fed will begin cutting interest rates sooner than markets are predicting.
The Pershing Square Capital Management founder said such a move could happen as soon as the first quarter.
The backdrop for risky assets will be challenging during the first half of next year with “spells of material weakness” before potentially improving, according to JPMorgan strategists led by Mislav Matejka.
The risk-reward for equities to “start fundamentally improving once the Fed is advanced with interest rate cuts,” they wrote.
Solita Marcelli at UBS Global Wealth Management says she agrees with the market’s assessment that U.S. growth, inflation, and rates will all head lower next year.
However, her view on the timing and size of U.S. rate cuts differs to the market – with potential for uncertainty and volatility.
“We believe investors should focus on quality,” she noted. “In fixed income, quality bonds offer attractive yields and should deliver capital appreciation if interest rate expectations decline as we expect.
In equities, quality companies with strong balance sheets and high profitability, including those in the technology sector, should be best positioned to generate earnings in an environment of weaker growth.”