December 14, 2023
Yesterday’s updated Summary of Economic Projections (SEP) clearly supports market expectations for a soft landing, especially when compared to the SEP from last December. The current SEP has expected GDP growth more than 2 percentage points higher, an Unemployment Rate that’s 80bp lower and core PCE inflation that’s 30bp lower than this time last year. The 75bp of rate cuts implied by the updated median dot comes entirely from lower inflation expectations with the ‘24 PCE forecast down 50bp to 3.2% from September’s forecast of 3.7%.
The Fed’s path of rate cut expectations closely matches 2-year Treasury yields with a lag. Some market participants have suggested getting rid of the Fed altogether and replacing it with the 2-year Treasury. The suggestion is usually followed with an estimate of money saved by omitting hundreds of Fed luncheons held annually. That’s a joke, but using 2-year yields to forecast Fed policy seems like a valuable suggestion. Consider that 2-year yields going into yesterday’s meeting were sitting at 4.67%, and the Fed’s revised ’24 dot coming out of the meeting was 4.65%.
Yesterday’s Fed meeting resulted in an assumed end of the hiking cycle, but we haven’t yet seen the type of yield curve steepening witnessed at the end of past cycles. The Fed’s dovish message resulted in some upside for equity markets, but the major indices rallied in anticipation and have been overbought for the last three weeks. Markets can stay overbought or oversold for weeks at a time but eventually need to unwind. Lack of further curve steepening from current levels would likely result in some SPX price consolidation. Given enough time, mild price consolidation in the 2-5% range could be enough to burn off overbought conditions. Curve steepening that results in a positively sloped 2/10 segment would likely generate further equity upside regardless of technical factors.