A Big Rally Sparked By “Any”

December 15, 2023

The stock and bond markets surged on Wednesday following the release of the Fed’s decision on interest rates. The impetus for the initial surge was a change in wording in the Fed’s policy statement. Specifically, the Fed said that the economy “has slowed from its strong pace in the third quarter” and that inflation “has eased over the past year.” But the kicker came a little farther down the policy statement where the Fed added the word “any” to this sentence: “In determining the extent of any additional policy firming that may be appropriate to return inflation to 2% over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” That change in wording, along with the Chairman’s surprisingly dovish commentary during the Q&A and the 50 basis-point downward revision to the Fed’s projection for the fed funds rate next year, have convinced investors that the central bank has now effectively ruled out any additional interest rate hikes. But more than that, the Chairman said the Committee has begun the process of deliberation about the timing of interest rate cuts. 

In response to a question about how the Fed will decide when to start cutting interest rates, Chairman Powell said this:

“So we’re aware of the risk that we would hang on too long. You know, we know that that’s a risk and we’re very focused on not making that mistake. And we do regard the two—you know, we’ve come back into a better balance between the risk of overdoing it and the risk of underdoing it. Not only that, we were able to focus hard on the—on the price stability mandate, and we’re getting back to the point where—which is what you do when you’re very far from one of them, one of the two mandates. You’re getting now back to the point where both mandates are important and they’re more in balance, too. So I think we’ll be—we’ll be very much keeping that in mind as we make policy going forward.”

This rhetoric was music to the markets’ ears. No longer do prospective home buyers have to worry about the possibility of 8% or 9% mortgage rates. No longer do banks have to worry about deposits fleeing in search of higher interest rates or unrealized losses on their huge bond portfolios. No longer do commercial real estate investors have to fear the inability to refinance loans when they come due. Ditto for a countless number of more speculative companies that have been sustained by ultra-low interest rates in recent years. And no longer does anyone need to worry about losing their job next year as the delayed impact of Fed rate hikes causes a recession. 

Sound too good to be true? Maybe it is. As I said in last week’s market commentary, in order to get from point A (which is today’s environment of unacceptably high inflation) to point C (which is a recession triggered by 525 basis points of interest-rate hikes), it is necessary to pass through point B (which is the “soft landing” scenario of steady economic growth and inflation falling back to the Fed’s target of 2%). So yes, the Fed is doing the right thing by signaling the end of rate hikes and the possibility of imminent rate cuts. The economy is clearly slowing dramatically from the breakneck third-quarter pace as evidenced by sharp declines in inflation, long-term interest rates and commodity prices. But that doesn’t necessarily mean that a soft landing is assured. Interest rates have dropped a lot, but they are still well above where they have been for almost the entirety of the past 13 years, and the amount of debt across the economy has nearly doubled. Is it reasonable to expect the Fed to pull this off without a hitch? 

Still, the market response to what’s now being called a Fed “pivot” has been nothing short of remarkable. But it’s really just been a continuation of the trend since October, when the 10-year yield topped out at around 5.02%. The S&P 500 has increased about 15% since then, and the 10-year yield is now all the way down to 3.93%. Those moves are translating to very Happy Holidays for a lot of investors. 

Our advice remains the same. Stay defensive, but stay invested, so as to avoid missing out on the handful of days (like yesterday and today) that can have a very meaningful impact on long-term portfolio returns.