2023-12-26 14:54:00
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Investing.com – A huge rebound in markets driven by the US Federal Reserve’s recent shift in policy on interest rates has some big-name fund managers concerned that markets now appear highly vulnerable to disappointing economic news.
Stocks and bonds have rallied over the past two months, receiving a big boost when the Federal Reserve dropped its biggest hint yet that it might start cutting interest rates as soon as next spring.
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In the short term, it enhances the festive mood. But it also means that major assets are now priced to perfection, with central banks cutting interest rates once more but without being forced into a recession. Major investors are concerned that these assumptions may not match, and that it will take very little to force a rethink in a year full of economic, political and geopolitical risks.
US government bond prices play a central role in the markets’ turnaround in late 2023. Benchmark 10-year rates have been rising since October, when yields hit 5 per cent – the highest level since before the financial crisis. At that point, investors were mirroring the message the Fed put out over the summer that interest rates would remain high over the long term to keep inflation down.
But throughout the fall, as inflation declined and a strong U.S. labor market showed signs of slowing, the Fed’s message began to shift.
Initially, the central bank indicated that higher yields were performing some of its responsibility, an acknowledgment that higher borrowing costs were beginning to take their toll. Then officials started talking regarding the possibility of lowering interest rates even as inflation remained above target. Yields, which move inversely with interest, fell.
But the biggest news came at Federal Reserve Chairman Jerome Powell’s regular press conference on December 13, when he began charting a likely path toward lower interest rates and presented forecasts for other officials who set interest rates, pointing to several cuts over the next year.
Analysts and investors quickly caught up, setting interest rate cuts earlier than they had previously expected. Subsequent efforts by Fed officials to cool market enthusiasm had little effect.
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Market expectations vs. Fed
Swaps markets show some investors are eyeing interest rate cuts of six quarter points next year, versus the Fed’s estimated forecast of three possible cuts.
Since those comments from the Fed, yields have fallen, falling below 4 percent, beating many Wall Street analysts’ predictions of where they might end up in 2024. The impact has rippled across other major government bond markets and sent stocks higher.
Some believe that the potential mixed signals sent by the markets are no obstacle to further gains. Days following Powell’s comments, Goldman Sachs, which had already set a target of 4,700 for the S&P 500 for the end of 2024, raised that forecast to 5,100, seven percent above prevailing levels.
Some fund managers are reluctant to take this view, partly because of how frustrating trying to make forecasts this year has proven. Investors have tried many times in vain to detect a shift in stance on interest rates from central banks that remain fixated on high inflation.
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Feeling confused
Investors were also puzzled by the failure of a widely expected recession and the associated decline in stocks. The accelerating revolution in the use of artificial intelligence has caused some large stocks to rise in market capitalization, causing stock indices to rise.
It took months of persuasion for investors to internalize the message from monetary policymakers that interest rates would remain high, especially following a group of US regional banks went bankrupt, only for market prices to collapse shortly following the message from central banks was absorbed.
The thorny issue now for investors is the US economy. Stocks forecast a healthy earnings environment for US companies while bonds point to a recession. Fund managers have been left nervously monitoring individual data points, especially on inflation, that threaten to spark huge market reactions.
On the other hand, a deep economic contraction might still occur. “There is a possibility that central banks have got this right and will be able to engineer a soft landing, but it is too early to declare victory,” said Daniel Ivaskin, chief investment officer at Pimco.
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