Last week, the stock market saw positive momentum as bond yields retreated, influenced by signs of a cooling labor market and services sector. These indicators reinforced the belief that the Federal Reserve is unlikely to pursue further rate hikes and may even consider rate cuts as early as June. Wall Street experienced a surge in optimism, with the S&P 500 marking its most substantial weekly gain of 2023. The VIX, often referred to as the market’s “fear gauge,” witnessed its most significant weekly decline since December 2021.
The bond market also witnessed a rally, with two-year yields dropping by 15 basis points to 4.84%. Concurrently, the US dollar recorded its most substantial decline since July. Additionally, the oil market saw a notable shift as the risk premium associated with the Israel-Hamas conflict dissipated, causing oil prices to fall below $81.
Market expectations regarding future interest rate movements have evolved, with Fed swaps indicating a mere 16% likelihood of another rate hike by January. Moreover, traders have fully factored in the possibility of a rate cut occurring in June, a shift from previous expectations of July.
Several economic indicators contributed to these market movements. The US service sector expanded at its slowest pace in five months, while job growth moderated, and the unemployment rate inched up to 3.9%. Nonfarm payrolls increased by 150,000 in the past month, following a downward revision of 297,000 in September. Wage growth also showed signs of deceleration.
Commenting on these developments, Florian Ielpo at Lombard Odier Asset Management in Switzerland stated, “The US economy showed its first cracks, but markets decided not to care.” The prevailing sentiment is one of optimism, and many investors are embracing a bullish outlook, whether in the equity or bond markets.
The recent market trends reinforce the Federal Reserve’s decision to maintain its pause in interest rate hikes, according to George Mateyo, Chief Investment Officer at Key Private Bank. These trends also reflect a “not too hot/not too cold” economic backdrop, which is welcomed by investors who were previously concerned about the possibility of an overheating economy.
In October, the pace of hiring slowed down, providing the Federal Reserve with room to continue its pause in interest rate policy as they monitor further developments in inflation. Russell Price, Chief Economist at Ameriprise, currently believes that the Fed has completed its rate hikes.
The Federal Open Market Committee (FOMC) recently voted to keep interest rates at a 22-year high for the second consecutive meeting. Fed Chair Jerome Powell emphasized that the central bank is proceeding cautiously and expressed uncertainty about the need for future rate hikes in the near term.
Federal Reserve officials have offered insights into their approach. Raphael Bostic, President of the Federal Reserve Bank of Atlanta, emphasized patience when it comes to interest rate decisions. Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, welcomed the slowdown in hiring but cautioned against overreacting to one month of data. Richmond Fed Chief Thomas Barkin indicated that his decision on future rate hikes would depend more on inflation reports.
Despite a robust week for the stock market, there are lingering concerns about Corporate America’s profit outlook. Several companies providing forward guidance for future quarters have reported estimates that fall short of analysts’ expectations.
Market sentiment is mixed, with some experts suggesting that the market may need more time to stabilize and could experience increased volatility in the coming months.
On the bond market front, bonds are becoming more attractive, and they are expected to outperform cash over the next year as inflation cools and central banks conclude their tightening policies, according to Christian Mueller-Glissmann, Head of Asset Allocation Strategy at Goldman Sachs Group Inc.
In summary, recent market dynamics highlight the Fed’s cautious stance on interest rates and the ongoing evaluation of economic indicators. While optimism has prevailed in the stock market, caution prevails regarding Corporate America’s profit forecasts. The evolving economic landscape continues to shape the Fed’s approach to monetary policy.
