How the ‘dot plot’ changes — and how Fed Chair Jerome Powell addresses those changes — will be the questions investors want answered this week
Stock-market investors will face the Fed’s first ‘dot plot’ of 2024.
U.S. investors may face a reality check this week when Federal Reserve officials release their updated projections for interest rates. Investors want to know if policy makers still expect to cut rates three times in 2024 as inflation still remains well above their 2% target.
Wall Street wrapped up a volatile week that brought new data showing that inflation remained elevated in February. Investors pricing in the first interest-rate cut by June now worry that policy makers have more reasons to hold off on cutting rates.
The central bank is expected to keep its policy rate unchanged at a range of 5.25% and 5.5% when it completes a two-day meeting on Wednesday.
That will put the spotlight on the release of the Fed’s latest Summary of Economic Projections on Wednesday, with market watchers focusing obsessively on one part in particular: the new “dot-plot.” The closely watched chart maps out where individual policy makers see the fed-funds rate in the future.
“The Fed is still likely to ease at midyear, June or July, but the FOMC [Federal Open Market Committee] meeting next week may formally extend the wait-and-see period by another one or two meeting cycles,” said Thierry Wizman, global FX and rates strategist at Macquarie. Wizman added that Fed Chair Jerome Powell could repeat that he needs a “little bit more” evidence that disinflation is sustainable before trimming rates.
The recent slowdown in the pace of disinflation may also motivate Fed officials to raise the median “dot” for 2024 and 2025, Wizman wrote in a Friday client note.
Policy makers have projected a total of 75 basis points of cuts in 2024, with a further 100 basis points of cuts penciled in for 2025, according to the Fed’s December policy meeting. Fed-funds futures traders now agree and have priced in three quarter-point cuts in 2024 — down from expectations of six or seven at the start of year, according to the CME FedWatch Tool.
Stocks haven’t seem bothered by hot inflation
So far this year, back-to-back hotter-than-expected CPI reports have brought sticky inflation back to the forefront of investors’ minds. The number of cuts has been dialed back aggressively in the interest-rate futures market over the past two months, but the stock market hasn’t seem bothered.
The S&P 500 closed at its 17th all-time high on Tuesday after the February CPI report, powering the large-cap index’s 7.3% year-to-date advance. The Nasdaq Composite has gained 6.4% so far in 2024, while the Dow Jones Industrial Average is up 2.7% over the same period, according to FactSet data.
“Investors are getting warmer to the idea that [if] we have higher rates for a little longer, [it] doesn’t really matter that much as long as companies can produce good earnings,” said Jimmy Lee, chief investment officer of the Wealth Consulting Group. Lee told MarketWatch in a phone interview that he expects “more favorable” inflation data in the second half of the year, which would then allow the Fed to adjust its rate projections “quicker.”
However, anxiety has been seen in the government-debt market, where 10-year and 30-year Treasury yields saw their biggest one-day advance in a month on Thursday, after February’s producer-price index also came in hot.
Neutral rate may creep higher, hurting bonds and stocks
To be sure, what will ultimately have the bigger impact on markets isn’t when the Fed starts slashing interest rates in 2024, but where rates lie in the longer term.
That’s why Wizman said longer-term Treasury yields could rise further this week if policy makers raise their estimate of the so-called neutral rate or equilibrium rate. “If the Fed raises the neutral rate, even by 25 basis points, I think it should have a bigger effect on the 10-year yield,” he told MarketWatch.
The neutral rate is the rate at which monetary policy is neither stimulating nor restricting economic growth, which also suggests inflation should be at target levels while the labor market remains healthy. Essentially a guidepost for monetary policy, the neutral rate cannot be measured or observed directly, but determines how restrictive or accommodative policy makers are in imposing the benchmark federal-funds rate.
The Fed’s projections in December put the longer-run neutral rate at 2.5%. That’s 275 to 300 basis points below the current policy target range of 5.25% and 5.5%.
Fed watchers and investors have debated over whether the neutral rate has changed as the U.S. economy keeps outperforming expectations. Some think the rate has possibly risen after hovering around the 2.5% level since 2019. If that is the case, it would mean fewer interest-rate cuts by the Federal Reserve in the next few years.
“I don’t think we’re going to see more of an adjustment with the first rate cut [after the meeting this week],” Wizman said. “What happens after the first rate cut is what’s relevant here, and the Fed may want to signal that it won’t get to the equilibrium rate for a while — but when it does, it’s going to be a higher equilibrium.”
Wizman said investors may want to “stay away from bonds” this week as the Fed meeting approaches because “the apprehension of the traders” will grow, which could trigger a selloff in the government-debt market.
Meanwhile, with U.S. stocks hovering not far from their record highs, there will also be “more downward pressure” on stocks this week if the Fed raises the long-term neutral rate, Wizman added.
The S&P 500 and the Nasdaq Composite on Friday suffered their second straight weekly losses, slipping 0.1% and 0.7%, respectively. Dow industrials fell less than 0.1% and have been down for three consecutive weeks, according to Dow Jones Market Data.
Comments