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The bears might still have a case, and one must acknowledge the known and unknown uncertainties until the year's end. However, as of mid-December, the prospects for those betting against a Santa Rally appeared less promising.

It’s worth noting that U.S. equities surged for a seventh consecutive week, propelled by a dovish stance from the Federal Reserve. Even though John Williams expressed some resistance, it seemed the market had largely tuned out dissenting voices by that point.

The equity rally played a crucial role in alleviating tight financial conditions, complemented by a substantial decline in bond yields since October and a pronounced weakening of the dollar.

As the S&P approaches record levels, market participants appear undaunted. The prevailing sentiment seems to be that there is no compelling reason to fade this rally until concrete evidence surfaces indicating significant economic or inflation headwinds.

While PMI data released on Friday provided some indications that the recent easing in financial conditions( FCI) may have started seeping into the U.S. services sector, conclusive evidence that FCI easing is jeopardizing the "last mile" of the inflation fight may take months to emerge. And with bulls on a stampede, the Fed might not realize it until it's too late. However, there is currently no clear evidence of a hard landing on the horizon, evident neither in the labour market nor in consumer spending.

Last week, risk assets experienced a broad rally following the Federal Reserve's policy announcement, accompanied by a further decline in Treasury yields, including a significant rally in the short end of the curve. In summary, as per the Federal Reserve statement, Chair Powell's press conference, and the dot plot, the Fed has concluded its rate-raising cycle, is not anticipating a recession, foresees a robust job market in the foreseeable future, and expects inflation to continue decreasing toward the target, setting the stage for rate cuts (75 bps) in the coming year.

However, it's crucial to note that the Fed will likely require additional improvement in inflation figures before initiating these cuts. This factor contributes to the belief that the actual rate pivot may not happen as swiftly as the current market expectations. Nevertheless, the market has achieved a substantial psychological victory, gaining clarity that this vicious tightening cycle has ended and at least three “insurance cuts”, barring an inflationary relapse, are coming down the pipe.

Notably, the bond market has rapidly priced in nearly a 25 bps Federal Reserve rate cut by March 2024, anticipating 150 bps of easing by the end of the following year. This has led to an approximately 80 bps decline in 2-year Treasury yields since the October high and a 110 bps decrease in 10-year yields since reaching 5% around the same period. This signifies a noteworthy easing in financial conditions, and it remains to be seen whether the Fed will allow this trend to persist or take measures to downplay the likelihood of rate cuts.

On Friday, key Federal Reserve lieutenants Williams and Bostic attempted to temper the rally. However, their efforts seemed as effective as throwing ice water on a penguin.

Nevertheless, the U.S. CPI report for November didn't present a particularly bullish picture, even though it largely met expectations. The headline inflation rate was reported at 3.1% year-on-year, matching the lowest level since inflation began to surge in March 2021. Core inflation, as anticipated, remained stubbornly high at 4.0% year-on-year.

While progress has been made, these ongoing high run rates in core inflation underscore that the Fed will likely need to maintain a stance of leaning into inflation for an extended period with restrictive policy rates. This outlook suggests a projection of 100 basis points of Fed easing in the coming year, but it is not expected to begin until the year's second half.

The six trillion Dollar question

Heading into 2024, one of the most critical questions for market participants revolves around the future of the $6 trillion parked in money market funds. The decision on how this substantial sum will eventually be deployed or invested is the 6 trillion dollar question for stock market operators.

The inherent paradox that Money Market Funds (MMFs) served as potential buffers for an extended market rally lies in the fact that these very same balances were, to a significant extent, responsible for systemic stability in 2023. They played a crucial role in supporting risk asset resilience by parking cash in the Fed's Reverse Repurchase Agreement (RRP) facility. This cash absorption in the RRP facility helped manage the substantial wave of Treasury issuance, alleviating reserve drain and indirectly facilitating a relatively smooth Federal Reserve Quantitative Tightening (Q.T.) process.

One could build a compelling case that a mass exodus from MMFs has the potential to be destabilizing, especially considering the uncertainty surrounding the threshold for reserve scarcity. As the RRP facility drains and the Federal Reserve continues with balance sheet runoff, the withdrawal of funds from MMFs could introduce volatility and disrupt the delicate balance in the financial system.