Fed Hikes Rates 50 bps, Signals Higher Peak

The Federal Open Market Committee (FOMC) meeting held in December 2023 reflected expectations, as the Federal Reserve lowered its interest rate hikes to 50 basis pointsHowever, the peak forecast for the federal funds rate in 2023 was adjusted upwards by 50 basis points to 5.1%, up from the 4.6% projected in SeptemberThis move signals that although the pace of interest rate hikes is slowing down, the ultimate rate will be higher than previously anticipated.

The FOMC statement emphasized the necessity of “ongoing” rate hikesMarket expectations suggest that two to three additional rate hikes are likely to occur starting from February 2023, with each increase estimated around 25 basis pointsEven with a dip in the October U.SConsumer Price Index (CPI) to 7.1% year-on-year from 7.7% previously, it remains far from the Fed's target of 2%. Chairman Jerome Powell reiterated the Fed's commitment to returning inflation to the 2% target.

On the day the interest rate decision was announced, the U.S

stock market initially appeared stableHowever, by Thursday evening, a significant decline was observed when the market opened lowerThe S&P 500 index fell by 99.57 points, or 2.49%, closing at 3895.75, while the Dow Jones Industrial Average lost 764.13 points, or 2.25%, finishing at 33202.22. The Nasdaq composite exhibited a steeper decline, down 360.36 points or 3.23%, at 10810.53. Investor sentiments turned sour as concerns about the Federal Reserve’s potential interest rate hikes raised fears of an economic recession in the U.S.

Despite the hope for a "Santa Claus rally" during the holiday season, the outlook for the stock market in the medium term remains challengingFactors contributing to this pressure include not only interest rate hikes but also the increasing likelihood of profit declines.

The core services sector shows signs of pressure, which can complicate the economic landscape

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While the CPI dropped below initial forecasts, Powell's firm stance during the FOMC meeting signaled a continued hawkish perspective on interest ratesThe mentioned expectation for a median federal funds rate of 5.1% again underscores the Fed's resistance to immediate rate reductionsPowell articulated the need for reductions in core personal consumption expenditures (PCE), an increase in unemployment rates, and a potential decrease in average hourly earnings.

Was the market convinced by Powell's words? Following the FOMC decision, U.Sequities saw a slight downturn, and the dollar experienced lossesThe dollar index continued to fall, while treasury yields remained largely unaffected by Powell's projections, indicating market indifference to his commentsOn the day of the announcement, the yield of the two-year treasury bond fluctuated only slightly, ranging between 4.136% and 4.161%.

However, by Thursday lunchtime, the market had begun to recalibrate its expectations

The U.Sstock market was under downward pressure while the dollar index regained its strengthThis market behavior seemed more influenced by a series of economic data released that day rather than the FOMC’s decisions.

The economic indicators that emerged on Thursday suggested that the U.Scould potentially be edging toward a recession, coinciding with the Fed's commitment to increase ratesNovember's retail sales reported a decline of 0.6% month-on-month, which starkly contrasted with the 1.3% growth seen in October and was the most significant drop since December 2021.

Excluding automobiles, retail sales fell by 0.2%, which was below the anticipated increase of 0.2%. Furthermore, the manufacturing sector seemed equally troubled, as reflected in the Philadelphia Fed Manufacturing Index, which came in at 13.8, while expectations had been set at -10. The New York Fed’s manufacturing index also displayed a contrasting figure at -11.2, far below expectations, highlighting considerable contraction evidenced since August.

All the economic data released on Thursday fell short of market expectations, instigating speculation that this slump could potentially moderate further rate increases from the Fed

Yet, the dot plot indicating a final rate of 5.1% suggests the Fed is prepared to continue with rate hikes.

The Fed’s reluctance to backtrack is understandable, considering that the economy’s and job market's slowdowns don’t pose an immediate threat while inflation remains stubbornly highNovember’s core CPI rose by only 0.2% month-on-month, marking its lowest increase in over a year, though year-on-year growth decreased to 7.1%, a significant drop from its peak of 9.1% in JuneThis still positions inflation significantly above the Fed’s target.

A dive into price changes reveals notable declines in energy prices, used car values, and medical servicesHowever, food prices increased by 0.5% month-on-month and by 10.6% year-on-year, coupled with rental expenses increasing by 0.6% and 7.1% respectivelyThis inflationary pressure remains a primary concern for policymakers.

Meanwhile, the stock market's valuation growth appears to face diminishing drivers

The recent recovery witnessed over the past six weeks, primarily propelled by falling U.STreasury yields, may be nearing its endpointFurthermore, Powell’s remarks continued to resonate with a hawkish tone, unaccompanied by any significant optimism regarding corporate earnings, which are perceived as being overly optimistic across industries.

Reports indicate that the historical patterns of November and December have generally been favorable for U.Sand Chinese stocks, with a potential “Santa Claus rally” on the horizonHistorical returns showcase a median of 2.1%, with a 71% success rate dating back to 1985. Previous corporate buyback trends are also anticipated to accelerate, further enticing investors in a market that previously surged on perceived rate pauses.

Nevertheless, despite an impressive rebound pushing the S&P 500 from a range of 3500 to about 4100, momentum has noticeably waned