FOMC meeting was dovish for risk assets
The Fed allows the economy to reflate despite evidence of growth and sticky inflation
TL;DR
The Fed has maintained a clear easing bias and is allowing the economy to reflate despite recent evidence of sticky inflation and accelerating growth (see recap of the FOMC meeting here by Darius Dale). I have put some key takeaways below:
The Federal Reserve's recent dovish policy decisions and accommodative stance on balance sheet runoff are positive for risk assets and provide a "green light" for equity markets.
The Fed's unchanged rate projections despite stronger inflation data suggest a high bar for changing course on rate cuts. Fiscal dominance is also forcing the Fed's hand toward easier policy (e.g. capping yields and supporting risk assets)
The U.S. economy shows resilience and is well-positioned for near-term growth (strong service & manufacturing growth, productivity, and housing statistics)
Inflation remains high but is expected to ease later this year due to housing and rental price disinflation.
AI is a transformative long-term theme but valuations for the "pure play" stocks are stretched. Exercise caution when investing in those names.
Healthcare and industrials sectors may be poised to outperform as sector leadership rotates away from mega-cap tech names.
Impact - no change to my portfolio positioning (still overweight equities - see previous post here). If you want to take more risk, a greater allocation to equities may be warranted (note: see disclaimer below).
Investor Expectations
The Federal Reserve's recent policy decisions were dovish (liquidity positive).
The Fed has raised GDP forecasts for 2024-2026 while lowering unemployment rate projections, signaling stronger economic growth without significant job losses.
Despite the improved economic outlook, the Fed has not materially changed its projected path for interest rate cuts (see market projections here).
While the Fed acknowledged that policy decisions remain data-dependent, its unchanged rate projections in the face of stronger inflation data suggest a high bar for changing course on rate cuts.
The Fed anticipates three rate cuts in 2024 and modest hikes in 2025-2026, indicating accommodative monetary policy that supports higher valuations for risk assets.
Government fiscal spending pushes the Fed toward easier policy to contain borrowing costs as debt levels surge.
One word of caution: The market pricing in higher rates than the Fed for 2026-2027, suggesting that investors expect the Fed will need to tighten policy further down the road to combat inflation (Dale, 2024).
Fundamentals
The U.S. economy demonstrates resilience and is well-positioned for near-term growth, despite potential headwinds indicated by some data points.
The U.S. economy continues to show resilience, as evidenced by strong job growth (U.S. nonfarm payrolls) and expansion in the service and manufacturing sectors. See the table above for more detail on those readings.
While some indicators, such as retail sales and consumer sentiment suggest potential headwinds, I believe that the economy is well-positioned to maintain its growth trajectory in the near term.
Inflation remains persistently high, but the Fed anticipates housing and rental price disinflation to provide relief later this year.
Recent inflation data has been consistently high, with 5 out of the last 6 indicators coming in hotter than expected, including CPI, PPI, and unemployment (see table above for detail).
Jerome Powell reiterated that the Fed expects the lagged impact of housing and rental price disinflation to flow through to official inflation statistics in the coming quarters (e.g. he thinks inflation will come down later this year)
The recent surge in productivity growth (U.S. productivity revision Q4: 3.20% vs. 3.10% expected) may provide some relief, but its sustainability remains uncertain.
Liquidity/Flows
Fed's accommodative stance on balance sheet reduction is a "green light" for markets. This could fuel a rally in risk assets.
The Fed has grown incrementally more dovish on shrinking its balance sheet, with discussions about slowing the pace of runoff. This indicates they are prioritizing liquidity and the smooth functioning of financial markets over aggressively tightening financial conditions to curb inflation (Dale, 2024)
Balance sheet runoff refers to the Fed's process of decreasing its balance sheet holdings of treasury securities which were purchased during quantitative easing programs. In this case, they plan to let treasury securities mature and not reinvesting those proceeds back into the treasury market.
Current reserve balances relative to GDP, bank assets, liabilities and deposits are significantly higher than in 2019 when the Fed had to abruptly halt its tightening.
Reserve balances represent the amount of money that banks hold in their accounts at the Federal Reserve. Higher reserve balances relative to GDP, bank assets, liabilities, and deposits suggest a lower likelihood of liquidity issues in markets or in the banking sector.
Over $6 trillion dollars parked in low-duration deposits and money market funds could rotate into risk assets as short-term yields decline.
Other Themes
AI is a transformative long-term theme but valuations for the "pure play" stocks are stretched. Exercise caution when investing in those names.
Nvidia, Microsoft, Meta, and Amazon responsible for over half of S&P 500 gains YTD. Nvidia alone accounts for 1/3 of S&P gains and 1/2 of NASDAQ 100 gains (Bianco, 2024).
The price-to-sales ratios for tech and communication services sectors are above dot-com levels (Bianco, 2024).
Healthcare and industrials sectors may be poised to outperform as sector leadership rotates away from mega-cap tech names.
If interest rates decline while the broader market churns, sectors like healthcare and industrials are likely to see inflows and outperformance as capital rotates out of extended tech leaders during the consolidation phase (Pies, 2024).
Bibliography
Dale, D. (2024, March 20). Real Vision Daily Briefing: Finance & Investing - #998 - Can the Fed Nail the Soft Landing? Real Vision Daily Briefing. URL here
Bianco, J. (2024, March 15). Real Vision Daily Briefing: Finance & Investing - #995 - Is a June Rate Cut off the Table? | With Jim Bianco. URL here
Pies, W. (2024, March 15). Real Vision Daily Briefing: Finance & Investing - #993 - Is the Gold Rally For Real? | with Warren Pies URL here