Fed's dovish pivot: 2024 rate cuts anticipated

Market rally in response to Fed's forward guidance

The Federal Reserve's (Fed) recent policy shift has set the stage for a significant market response. This change in stance, widely expected by market participants, has led to a rally in stocks, bonds, and gold while simultaneously causing the US dollar to weaken and yields to decline. 

Furthermore, Asia's tech sector has benefited from this shift in market sentiment.

Federal Reserve’s key statements

The Fed has opted to maintain the Federal Funds rates at 5.25%-5.5%. However, the central bank has made it clear that it is departing from its prior aggressive rate-hiking stance. The Fed now anticipates three quarter-point rate cuts in the coming year, aligning with market expectations. While the Federal Open Market Committee (FOMC) does not consider further rate hikes as their primary scenario, it remains open to adjustments as economic conditions evolve.

Dot plot projections: Three rate cuts in 2024: The dot plot, a visual representation of the Fed's rate projections, now shows a forecast of three rate cuts in 2024, exceeding the market's consensus of two. This forecast implies a total of 75 basis points of easing, surpassing the previous estimate of 50 basis points. By the end of 2024, the Fed funds rate is expected to reach 4.6%, according to the projections, down from the earlier projection of 5.1%.

US economy's resilience: This year has seen surprising strength in the US economy in terms of both growth and employment. The Federal Reserve aims for a "soft landing" to avoid a recession, balancing its dual mandate of price stability and maximum employment. Fed Chair Jerome Powell has been working to bring inflation back to its 2% target by aggressively increasing rates in the last two years, aiming to slow economic activities gradually without a crash while keeping the unemployment rate low. This is indeed a delicate balancing act that the Fed intends to continue pulling off moving into 2024.

Market response to the Federal Reserve's statement

The Fed's announcement triggered a significant market rally, impacting various asset classes. Currencies strengthened against the dollar, while global shares and corporate bonds posted robust gains.

• Impact on key market metrics: The S&P 500 extended its gains by 1%, the Dow Jones Industrial Average hit an all-time high above 37,000, and the two-year Treasury yields dropped by 25 basis points to around 4.5%. Swap contracts were repriced to reflect expectations of 130 basis points of easing over the next 12 months.

S&P 500

Dow Jones Industrial Average

• Depreciation of the US dollar: The US dollar, as measured by the DXY index, depreciated by nearly 0.9%, reaching its lowest point since August. This substantial drop resulted from a significant decline in US Treasury rates, driven by the Federal Reserve's unexpectedly dovish guidance. This shift did not catch market participants by surprise, as they had anticipated this change.

• Gold prices surge: Notably, precious metals experienced an extremely bullish reaction to the statement and comments by Chairman Powell. Both gold and silver had exceedingly strong moves to the upside. Gold prices surged by more than 1% to reach 2,004.79 USD per ounce as of 7:34 pm (GMT) on Wednesday, 13 December 2023. US gold futures settled 0.2% higher at 1,997.30 USD.

• Global equity rally: Global stocks extended their winning streak for a sixth consecutive session, with equity benchmarks in Australia, South Korea, and China registering gains exceeding 1%. Chinese tech companies, in particular, drew attention, leading to a more than 2% opening increase in the Hang Seng Tech index.

Sustainability of the stock market rally? Uncertainty looms

In closing, while the Fed's recent dovish pivot has fuelled optimism, caution is warranted. Market history reveals the peril of relying too heavily on rate-cut expectations. Overvaluation in stocks and unrealistic valuations pose risks to the current rally. The Santa Claus rally, often short-lived, underscores the futility of trying to time the market perfectly.

Traders should exercise vigilance, diversify portfolios, and focus on long-term fundamentals. Attempting to predict short-term market movements can lead to missed opportunities or significant losses. As we navigate these uncertain times, a disciplined and informed approach, rather than market timing, is key. The allure of a Santa Claus rally should not overshadow the importance of prudent decision-making and risk awareness. Caution is paramount as we acknowledge potential headwinds in the dynamic financial landscape ahead.