December 14, 2023
Good morning,
Color me wrong! On Monday, I commented that the market set-up going into yesterday’s FOMC meeting was likely bearish in the belief that participants could not contort an unchanged Fed statement any further than they already had at the November meeting. What I missed was the change in Fed posture yesterday – Oof!
If the Fed kicked off a market party at its November meeting, it unleashed a full-fledged financial Roman Bacchanalia at yesterday’s announcement (sorry, I couldn’t resist; we flew back from the ancient city yesterday). Perhaps the most stunning development has been the blow-out in market rate-cut pricing for next year, which currently stands just below 160 bps; that’s nearly half a percent more than at the open yesterday morning. In this context, yesterday’s rally in everything makes sense.
What’s interesting is that this isn’t even the most one-year-forward easing that markets have priced in this year. That honor goes to this past March’s banking crisis, which briefly priced in more than 170 bps of cuts over the ensuing 12 months. Other than that, though, you have to go all the way back to early 2008, and the emergency easing to find more rate cuts being priced in.
Question: “Is this excessive?” On the one hand, the market has only ever priced easing like this during times of severe financial stress. On the other, 2022 saw an unprecedented degree of priced (and delivered) rate hikes, and this may simply represent the flip side of the same coin.
The move looks to be overdone to me, and perhaps it will be in the long run. We know that markets tend to overshoot in the short-term, and as I said in November, this rally will likely persist through the end of the year and get so overbought that any disappointment when a market is priced to perfection (as this one is quickly getting) will lead to a natural correction in January. An interesting question for early next year is whether the rate-cut-pricing frenzy sort of eats itself by spurring so much wealth creation/demand boost/ commodity price rise that the inflation outlook deteriorates, freezing the Fed’s hands from delivering the early rate cuts that market pricing now craves.
As I am reminded every darn day lately, this is a humbling business.
Be well,
Mike
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