Financial News for the Week of January 5th, 2024

After a festive December where a sharp pullback in long-term yields sent risk assets higher, markets have gotten off to a much more sober start in 2024. Investors have seemingly adjusted their New Year’s resolutions, resulting in more moderate expectations for interest rate cuts this year. Cuts totaling 150 basis points by the end of 2024 remains the dominant scenario. The probability for more aggressive policy loosening (i.e., 7 cuts) has fallen sharply, while the probability of slightly less aggressive loosening (i.e., 5 cuts) has increased (Chart 1). In line with these developments, the 10-year Treasury yield has recouped some of the lost ground, rising from 3.8% at the end of December to near 4% recently, and equity markets have pared back year-end gains, with the S&P 500 down 1.6% from its recent peak.

The minutes from the December FOMC meeting contributed to the softening in expectations for interest rate cuts this week. After the Fed signaled that the policy rate would head lower in 2024, there was an anticipation that rate cut talk may have featured heavily at the last meeting. Committee participants confirmed that the policy rate was “likely at or near its peak for this tightening cycle”, given the reduction in inflation in 2023 and “growing signs of demand and supply coming into better balance in product and labor markets”. But, meaningful debate on rate cuts was missing. Instead, the discussion was somewhat more balanced, touching on both the risks of maintaining rates in a restrictive position for too long and the risks of prematurely easing policy. Participants noted that their outlooks were associated with an “unusually elevated” degree of uncertainty and stressed the importance of maintaining a data-dependent approach to setting monetary policy.

Speaking of data, this morning’s payrolls report showed that hiring unexpectedly accelerated in December, with the U.S. economy adding 216 thousand jobs (see commentary) in financial news. However, a downward revision of 71 thousand jobs to the prior two months limits some of the enthusiasm of this upward surprise. On a three-month moving average basis, hiring is still trending lower, which suggests that restrictive monetary policy continues to work as intended, cooling labor demand. Nonetheless, other aspects of the report still play in favor of showing some caution on easing monetary policy. The unemployment rate held steady at 3.7%. With the labor market still tight, wage growth gained some ground in December (Chart 2). A recent pullback in the job ‘quits’ rate – a leading indicator of labor costs – suggests that wage growth is nonetheless poised to cool ahead.

Other data reports were a mixed bag. Consumers increased vehicle purchases in December (up 3.2% to 15.8 million annualized), although this appears to be partially related to the return of year-end discounts (see here). Meanwhile, the ISM indexes signaled softness. There was a slowdown in the expansion of the services side of the economy, and the manufacturing sector remained in contraction for the 14th month in row in December, albeit slightly less so on the month.

All factors considered, a loosening in monetary policy is coming, but we anticipate the Fed will show a bit more caution, with the first rate cut not likely to come until the second half of the year.

Admir Kolaj, Economist | 416-944-6318