U.S. stocks continue to climb, reaching near two-year highs, despite cautionary remarks from Federal Reserve Chairman Jerome Powell about the timing of rate cuts. In a speech at Spelman College in Atlanta, Powell stated that it would be premature to speculate on when policy adjustments might occur. However, he reiterated that the Fed remains prepared to raise interest rates if necessary in order to achieve its annual inflation target of 2%.
While the Federal Reserve has control over short-term rates, currently ranging from 5.25% to 5.5% at a 22-year high, its influence over longer-term rates is more limited. These rates, which affect the U.S. economy as a whole and impact finance corporations and households, have actually decreased without any intervention from the Fed. This trend is seen as a positive for the stock market, according to David Kelly, chief global strategist at J.P. Morgan Asset Management.
Kelly also believes that inflation is heading towards the Fed’s target, regardless of whether central bankers are willing to acknowledge it. Recent data shows a slowdown in inflation, supporting this claim.
The Dow Jones Industrial Average (DJIA) experienced its best month since October 2022, while the S&P 500 index (SPX) and Nasdaq Composite Index (COMP) saw their largest gains since July 2022. These increases were largely driven by easing inflation and declining benchmark borrowing costs for the U.S. economy.
Currently, the Dow is trading above 36,000 for the first time since January 13, 2022, coming within 2% of its record close of 36,799.65 set on January 4, 2022. The S&P 500 is hovering around 4,590 and may achieve its highest close since March 2022 if it surpasses 4,588.96, as reported by Dow Jones Market Data.
Simultaneously, the 10-year Treasury yield (BX:TMUBMUSD10Y) has experienced a significant drop, falling approximately 75 basis points within a few weeks. As of Friday, it stands at about 4.21%, down from its 16-month high of 5% in October.
Market Anticipates Rate Cuts as 10-year Treasury Yields Retreat
Investors are signaling their belief that lower inflation is on the horizon, according to Kathy Jones, chief fixed income strategist at Schwab Center for Financial Research. This sentiment is reflected in the recent decline in the 10-year Treasury yields, which had briefly climbed to 5% earlier. However, Jones suggests that this temporary increase does not necessarily imply continued strong economic growth as previously anticipated. Rather, she points out that indicators such as slowing demand and falling U.S. benchmark crude oil prices indicate a potential economic slowdown.
Traders are increasingly anticipating rate cuts next year, as evidenced by the odds of a 25 basis point rate cut in March being pegged at 60% according to the CME FedWatch Tool. Despite this, J.P. Morgan Asset Management’s Kelly believes that the Federal Reserve will be hesitant to lower rates quickly.
While the possibility of higher short-term rates may persist, the focus will also remain on 10-year rates. These rates have a more direct impact on corporate earnings and consumer spending, which play significant roles in driving the overall U.S. economy.
Considering different scenarios, Jones suggests that the 10-year rate could potentially decrease to as low as 3.5% next year if a mild recession were to occur, although this is not Schwab’s official forecast. On the other hand, Kelly believes that a drop below 4% is unlikely unless there is a significant economic setback that triggers recession concerns and prompts the Fed to implement multiple rate cuts.
In assessing the Federal Reserve’s approach to rates, Kelly humorously compares it to someone who is consistently tardy. The Fed has been known to be cautious and deliberate in its decision-making process.