Market Note (Special Edition) – March 22, 2024

By Hightower Great Lakes on March 22, 2024

Fed Day

Yesterday the Federal Reserve held the benchmark rate unchanged at 5.25-5.50%, in line with market expectations. Fed Chair Powell maintained a dovish sentiment, sticking to the Fed’s current stance that it must see more evidence that inflation is coming down towards its 2% target before rate cuts can begin.

Powell mentioned a few times that while January and February inflation prints did come in hotter than expected, seasonal factors played a big part in the numbers. Powell also acknowledged that quantitative tightening needs to slow, which we will see in coming months.

Interestingly, the Fed Committee expects growth to be stronger, inflation to remain elevated and unemployment to remain around 4% – all good for better long-term earnings and equities. This is why the market rallied on the news as most investors were expecting a more hawkish Fed.   

All eyes were on whether any changes would be made to the Fed’s dot plot 2024 expectations. It remained stable, with Fed officials still seeing the fed funds rate ending this year at 4.6%, indicating three 25 bp cuts.

Furthermore, 17 of the 19 voting members see at least some rate cuts this year, with two believing no decrease in the policy rate will be necessary. Only one official believes the Fed will cut rates by more than 0.75% this year, down from five officials in December.

Fed Outlook: Stronger GDP, Elevated Inflation, Tight Employment

As mentioned above, the specifics from the Fed’s expectations: real GDP growth is expected to be up 2.1% in 2024 vs. 1.4% in December. Stickier inflation led to a slight uptick in core personal consumption expenditure expectations for 2024 at 2.6% vs. the initial 2.4%, but still towards the Fed’s 2% target overall.

Also, the unemployment rate forecast ticked down 0.1pp to 4.0% from 4.1%. This likely seems too low in our view especially if GDP and inflation targets remain at 2%. That said, 4% unemployment remains well below the historical average of 5.7% and is a plus for the U.S. economy long-term.

Fed officials believe three rate cuts this year will be sufficient in their fight to bring inflation down to 2%. This is positive for the soft-landing narrative and risk-on assets: the Fed did not change its rate cut expectations on top of expecting higher inflation and growth this year. It believes the current policy stance will be adequate and does not warrant any changes.

Chart 1: Core PCE y/y Relative to the Effective Fed Funds Rate[1]

Looking Beyond 2024

Fast forwarding to 2025, the median Fed projection shows rates ending the year at 3.9%, up from the previous estimate of 3.6%. This implies three cuts in 2025 rather than the previous expectation of four. It also increased the long-term policy rate forecast to 2.6% from 2.5%.

The Fed has maintained its “higher for longer” belief through less rate cuts over the next two years and a higher terminal rate. With that said, they do not think this will affect growth, with median 2025 and 2026 real GDP expectations at 2%, up 0.2 pp and 0.1 pp respectively from December.

Market Reaction

Given the continued belief in strong economic growth, the broadening out of equity market investments should continue – this also implies better earnings for longer, which is a clear positive for equity markets. Markets reacted positively to the release with the S&P 500 closing up 0.89% and the Nasdaq ending up 1.25%.

Risk-on assets rallied, with the ARK Innovation ETF (ARKK) closing up 3.50%. The probability for a 25 bp rate cut in June spiked to 70%, up from 55% Tuesday according to the CME FedWatch Tool.[2] The chance for a following 25 bp cut in July rose to 38%, up from 25% Tuesday.

One item to note – while the short end of the bond market reacted positively, the long end remained steadfast at the current level. This will keep us watching the curve in the bond market. Overall, the Fed remains confident that it will achieve its goal of bringing inflation to 2% while supporting economic growth and a strong labor market.

Click here to read last week’s Market Note (2/26).

Disclosures

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[1] Source: Factset. As of March 20, 2024.

[2] Source: CMEGroup. As of March 20, 2024.