After Stormy Waters, Will Fed Get A Glide Path?

Why it’s still a tightrope-walk to an economic soft landing.

Greetings after a rather foamy year in which the S&P 500 ended up 25 percent, flirting with a record high, and the Nasdaq Composite leapt around 45 percent, propelled by the gravity-defying “Magnificent Seven,” comprising Meta, Microsoft, Nvidia, Alphabet, Amazon, Apple and Tesla. 

Globally, the MSCI World Index, which tracks stocks across 47 countries, jumped more than 20 percent, amid sharp price swings.

Whether stocks will extend their so-called “Santa Claus rally” to enjoy the January Effect, where shares traditionally notch gains, remains to be seen – prices sputtered out of the gate on the first trading day of the New Year – but market participants seem determined to stay upbeat.

JPMorgan forecast “growth, resilience, inflation persistence” and cautioned “humility in forecasting how this tension is resolved” for the first half of 2024 in a recent report. Indeed, escaping the past few years of sky-high prices will continue to be a genuine challenge. The bank is expecting “elevated inflation” as “the substantial unwind of the post-pandemic global inflation shock now under way proves to be incomplete.” (Uh, that’s a word-salad way of saying that bottlenecks in the global supply chain are fading, but not yet past.) In fact, the bank says rising air and shipping freight costs may mean some higher prices will hang on.

Just a few days before Christmas, Wall Street received word that a key gauge of inflation, the Personal Consumption Expenditures (PCE) price index, declined 0.1 percent in November from the prior month, bringing the annual inflation rate down to 2.6 percent. That marked the first time the PCE index fell on a monthly basis since April 2020. 

The upshot? Inflation, at least for now, is cooling more than expected, despite the fact U.S. consumers shattered all records during the 2023 holiday shopping season. According to Adobe Analytics, the same Americans who claimed to be stressed out about the state of the economy still shelled out $38 billion from Thanksgiving to Cyber Monday, up 7.8 percent on the year. 

The PCE gauge is watched closely by the U.S. Federal Reserve, which is aiming for 2 percent inflation on average over time. The latest reading confirmed that the Fed is closing the gap to its target. This comes after it raised interest rates 11 times to break the back of soaring inflation, which peaked at more than 9 percent on the year in June 2022, representing the biggest increase since 1981.

JPMorgan noted that markets tracking interest rates are now projecting “a complete return to target in the U.S. and Western Europe over the coming two years,” with U.S. inflation on target by 2025, amid steady growth in gross domestic product and stable unemployment rates. 

In December, the Fed decided to hold its federal funds rate at 5.25 percent to 5.50 percent. “Inflation has eased from its highs, and this has come without a significant increase in unemployment,” noted Fed Chairman Jerome Powell, adding, “That’s very good news.” 

The Fed expects GDP growth to slow in the New Year, but remain positive. In other words: no recession. “GDP surprised to the upside in 2023, validating our out-of-consensus view that the U.S. economy would avoid recession,” Goldman Sachs wrote in a note on New Year’s Day. It observed that both stocks and bonds have been far more reactive than normal to surprises in the market data, “reflecting the intensity of the ‘recession vs. soft landing’ debate.” 

There’s even been big talk of as many as a half-dozen interest-rate cuts in 2024 – though if things go as smoothly as hoped, that should not be necessary. “Markets are salivating over the possibility of as many as six interest rate cuts in 2024,” Raymond James wrote in a note out this week. “But we believe that is overly optimistic; we favor three or four. More rate cuts than that would likely mean the economy is struggling more than we anticipate.”

For its part, the Fed has tipped its hand in favor of cutting rates by 25 basis points three times in 2024. Fed officials have also made clear a strong willingness to hike rates again if inflation flares up. The Fed’s latest minutes, which will be released Wednesday, may offer some insight into when officials plan on cutting rates, with market participants looking to as early as March as a starting point.

Still, not everyone is feeling rosy. Former chief North American economist for Merrill Lynch, David Rosenberg, says he thinks the end-of-year stock rally was overdone – a widely held view, at this point – and the U.S. economy is weaker than it appears. 

“We have been in a ‘soft landing’ all year long, as was the case in 1979, 1989, 2000 and 2007,” he warned. “The soft landing is the transition phase — the bridge — from the expansion phase of the business cycle to the contraction phase, which I believe will be next year’s story. The Fed has locked itself into a downturn.”

Rosenberg correctly predicted the dot-com bust and the Great Recession – could he be right? What happens next will be crucial to determining the national mood as voters cast their ballots later this year for the next U.S. president.