The Federal Reserve pivoted off of “higher for longer” with regard to interest rates at this week’s meeting. Chairman Powell came into the Fed meeting being quoted as recently as December 1 saying “We are prepared to tighten policy further” implying that they may not be done raising interest rates. He shifted at the Dec 13th meeting saying that rates have peaked, and the Fed is looking at three rate cuts coming in 2024. Wait, what? That is quite an adjustment in less than 2 weeks and the asset markets responded violently. The interest rates on the longer end of the curve came crashing down and the Dow Jones Industrial average rocketed to a new all-time high. The move higher in stocks and bond prices was accelerated by short-sellers that got caught and had to buy back in a frenzy. The 10-year treasury bond yield – which printed over 5% just over a month ago in October – crashed down to 3.9% and so far hasn’t bounced. That is quite a remarkable move. Why would the Fed change verbiage so drastically? Is this a rerun of the fall of 2018 when the Fed tried to raise rates and immediately backed off because of warning signals from the overnight repo market? Is the Fed seeing something in the banking system that is prompting them to back off the “higher for longer” mantra? The big banks still have north of a half a trillion dollars in unrealized losses in their bond portfolios. Is the Fed trying to rally those prices to avoid banks having to realize those losses?
The long-awaited recession still hasn’t materialized in the U.S. but parts of Europe are clearly in a recession. Interest rates are still sitting much higher than anyone reasonable would have thought that the world’s economies could have stood up to. It appears that we have come to the conclusion of that pleasant surprise, however as the Fed is strongly hinting at lower rates quickly. Now we are wondering if lowering interest rates can help maintain a stock market rally considering there are likely some downturns upon us in the economy. Can the Fed truly engineer a soft landing of the economy considering the wildly volatile policies that they have implemented over the last three years? Or are unintended consequences of their actions inevitable?
We have been mentioning that we expected a Santa Claus rally in stocks – but last week even outdid our expectations. If you have been nervous about your stock portfolio being too risky, this short covering rally is providing a nice escape point to sell some positions. Our guess is that asset prices will probably continue higher for the short term but that is just a guess and the Fed may actually be spooked by something serious that could start weighing on stock prices.
One indicator worthy of note is the quick move in 30-year mortgage rates – take a look…
We keep hearing about pending doom in the residential real estate market but mortgage rates coming down would clearly stem some of the pain in that market. We don’t need to return to all-time low mortgage rates to support real estate – there is simply a shortage in homes in this country. The looming danger in refinancing needs for corporate bonds would also be ameliorated by the slide lower in interest rates. There are many things that could be restimulated by interest rates coming back down and we should remain cautiously optimistic that 2024 can get started without any serious setbacks economically. At the same time we should remain forever vigilant as the Federal Reserve has engendered an unstable interest rate system with their shenanigans specifically in the last three years.
Regards and good investing,
Greyson Geiler