Trading the week ahead when the Fed goes silent

In the upcoming sessions, the direction of US interest rates is expected to be influenced by economic data releases and the market's response to the Treasury supply dynamics.

When the Fed goes silent ahead of the January policy meeting, the market does not necessarily fly blind; instead, it creates an environment where market participants will zero in on incoming economic data. Additionally, the market's response to the issuance of new bonds, reflecting the supply of government debt dynamics, will be closely watched. Investors will assess how demand for these bonds impacts yields for short-, medium-, and long-term interest rate expectations.

In the early months of 2024, Treasury prices have declined, leading to higher yields. Despite the rise in bond yields, equities have not been significantly impacted, and the S&P 500 even achieved a new record high. This occurred despite the notable yield increase at the front end of the yield curve against a backdrop of resistance from policymakers who expressed concerns about aggressive pricing for potential rate cuts.

But as discussed at length last week, the prevailing sentiment suggests that the path of least resistance for the Fed is leaning toward a minimum of 75 bp of insurance rate cuts this year. But the key uncertainties revolve around the pace of cuts and, perhaps significantly, the timing of such monetary policy adjustments.

However, we will likely have a better idea of where March cut probabilities sit after Friday’s release of the US PCE deflator report for December, which is anticipated to provide evidence that inflation is slowing and possibly tipping the scales in favour of the March rate cut.

Nonetheless, it was somewhat refreshing to witness stocks moving higher in response to positive macroeconomic data, suggesting that good news may once again be interpreted positively in the market. To the degree this good news is good news, the environment holds up. We will soon find out by the end of the week.

The upcoming critical macroeconomic event leading to this month's Federal Open Market Committee (FOMC) meeting is the advance reading on the fourth-quarter US Gross Domestic Product (GDP). Consensus forecasts anticipate a 2% growth rate for the headline GDP figure and a 2.5% expansion in the personal consumption component. Investors will closely watch these figures as they provide insights into the overall economic performance and consumer spending trends, potentially influencing market sentiment and expectations leading to the FOMC meeting.

As of January 19, the Atlanta Federal Reserve's GDPNow forecast stands at 2.4%, offering an early indication of the potential growth rate for the current quarter.

While there may be a temptation to anticipate the risk associated with a strong GDP reading leading markets to adjust their expectations for a March rate cut, the broader focus could shift toward the core Personal Consumption Expenditures (PCE) metric. Notably, the final reading for the third quarter GDP revealed a downward revision in the core PCE print to 2%. Investors will likely pay close attention to this inflation measure, which is crucial in shaping monetary policy decisions.

The impact of these developments on the likelihood of a March Fed rate cut remains a matter of debate. The upcoming pivotal event is Jerome Powell's press conference on January 31, where his messaging could significantly influence the betting odds for a Q1 rate reduction. The Federal Reserve will have input from additional data points by March, which will likely substantially impact market expectations more than the events in the coming week.

There is a conceivable threshold regarding equities where a reduced expectation of Fed cuts could turn negative without a corresponding acceleration in earnings growth expectations. However, the stock market has experienced a positive trend in 2024, with traders trimming March rate-cut odds to around 40% last week and implied cuts for 2024 by approximately 30 basis points. Surprisingly, this adjustment did not hinder equities from reaching new highs.