Sentiment Turns - 4th Quarter 2023
The fourth quarter may signify the turning point in U.S. monetary policy that markets have long awaited. Though the Federal Reserve (Fed) will not declare victory until success is well proven, it is clear they are winning the fight against inflation. Inflation data as measured by the CPI (consumer price index) and PCE (personal consumption expenditures index) continue to fall faster than economic forecasters have predicted.
There is room to go before inflation has reached the Fed’s preferred long-term rate of 2%, as the October CPI reading was 3.1%. However, the trend is clear. Wage growth has declined significantly from the peak seen in 2021. The prices of oil and consumer-watched gasoline have declined steeply in recent months, even amidst Middle East turmoil. Supply chains once snarled have been reworked. And economic growth has moderated. Fed officials have all but said there will be no additional rate hikes. Markets are now anticipating a decrease of 150 basis points (1.5%) to the federal funds rate in 2024. What a difference two months make:
Source: Bloomberg LP
If this graph looks familiar, it should. In our 1st Quarter 2023 commentary, a very similar graph was used, but with a very different interpretation. In early 2023, markets were anticipating the Fed would cut rates to help stem the impact of an impending recession due to excessively high rates. Since then, the U.S. economy has shown great resilience and today, with conditions stable, markets anticipate a falling in rates as a sign that the Fed has successfully reduced inflationary pressures. This places policy makers in an advantageous position of being proactive in their work to provide stable growth and prices.
Financial markets have swiftly celebrated the headlines. Much has been written about the effect that just a handful of stocks have driven, but interest-rate-sensitive stocks and bonds have recently come to life too. The IPO market, which was frozen for well over a year is thawing, and the eventual return of successful underwritings will bolster confidence and risk taking, all good signs for markets and economies. We expect this broadening of the rally in asset prices to continue as long as the current narrative of lower inflation and stable economic growth remains intact. A so-called ‘soft landing’ in which inflation falls without triggering a painful economic recession appears more likely.
This positive twist may not yet be recognized by the typical U.S. consumer’s pocketbook, and there are signs purchasers may be tiring. According to the Federal Reserve Bank of New York, Americans’ credit card balances amassed $1T in 2023, the highest since it began tracking the data in 1999. It’s no coincidence this news comes shortly after Federal student loan interest payments resumed in September. In addition, the ever-expanding national debt now consumes more than $1T annually in interest payments. There appears little ability or determination from leaders to reduce its size.
As the year progresses, we feel the upcoming U.S. elections will inject volatility into global markets. History indicates that market participants are less concerned about specific political policies and more about a stable framework from which to operate. At EPIQ, we continue to see value in fixed income due to return characteristics that are the most compelling in fifteen years (rates of return are greater than rates of inflation). Over the last several months, we have selectively added exposure and duration to fixed income portfolios to lock in higher interest rates and credit spreads. We won’t pretend to know what comes next. What we do know is that markets move very quickly, and change is the only constant when it comes to investing.
Thank you for reading and please reach out to continue the conversation.
EPIQ Partners