As the market digested the Fed's slowdown in raising interest rates, the Dow took the lead in entering a technical bull market last week, and the VIX, a measure of index volatility, fell to its lowest level this year.
Fed Chairman Jerome Powell's latest speech suggests that aggressive policy is coming to an end, but the task of achieving the long-term inflation target will stay the course.
The flow of funds shows that investors choose to take profits and leave the market due to renewed economic concerns, and the game around next year's policy path may become a point of view in the market's long-short decisive battle.
The Fed's December policy is basically set
Federal Reserve Chairman Powell's latest statement at the Brookings Institution last week set the tone for the December meeting, and the aggressive rate hike policy that began in June is likely to gradually slow down from next week's meeting.
His views are also similar to the previously released meeting minutes and the latest statements of several Fed officials, showing that a major consensus has been reached within the committee.
The Fed previously attributed the change in policy stance to uncertainty about the lagged effect and magnitude of monetary policy's impact on economic activity and inflation.
The latest data show that the trend of inflation peaking and falling is becoming more and more obvious.
The October personal consumption expenditures price index (PCE) announced last week increased by 6.0% year-on-year, and the core PCE, which the Federal Reserve is most concerned about, increased by 5.0%, both of which have fallen back.
The previously released Purchasing Managers Survey (PMI) shows that the gradual balance of consumer demand and the improvement of the supply chain have caused the upstream cost pressure of enterprises to continue to fall, reducing inflation.
Bob Schwartz, a senior economist at Oxford Economics, said in an interview with a reporter from China Business News that the cooling of prices will undoubtedly give room for policy adjustments, and the Fed will take action in December.
But it is clear that inflation remains high and a pause in the tightening cycle looks far away.
It is worth noting that while prices are peaking, the downward pressure on the economy is also increasing.
The Institute for Supply Management's ISM manufacturing index, a key barometer of U.S. factory activity, fell to 49 in November, entering contraction territory.
Services PMI surveys due in the coming week are also expected to show a further slowdown in expansion, nearing the boom-bust line.
The Federal Reserve's latest Beige Book on economic conditions shows that high inflation and interest rate hikes are heating up economic uncertainty.
CME’s interest rate monitoring tool shows that the probability of raising interest rates by 50 basis points in December is close to 80%, and the current round of interest rate peak expectations next year has dropped from 5.07% last month’s high to 4.95%. The Fed rate will drop to 4.51% by the end of next year, which means room for two rate cuts.
Affected by this, the 2-year U.S. bond yield, which is closely related to interest rates, fell below 4.30%, and the U.S. dollar index fell below the 104 mark.
Within the Fed, a cautious view is taken on an early shift in policy.
New York Fed President John Williams and St. Louis Fed President James Bullard said recently that a rate cut may not come until after 2024.
Powell also tried to avoid any discussion of rate cuts, saying there was a long way to go to restore price stability and that history strongly warned against premature easing.
The continued tightness in the job market may bring uncertainty to the achievement of the inflation target. The November non-agricultural report shows that the recovery of wage growth and the low unemployment rate continue to put pressure on corporate labor costs.
Many Fed officials had worried that rising wages due to a tight labor market would put upward pressure on inflation.
Schwartz told reporters that there is no obvious sign of slowing down in the job market, wage growth is accelerating, and the Fed needs to cool down the labor market faster to achieve the goal of a soft landing.
But that path is already narrow, and he believes that unless more progress is made in reducing service sector inflation, interest rate risk will be skewed to higher levels.
Schwartz expects the Fed to slow its pace of rate hikes to 50 basis points next week and then choose to pause after raising interest rates by 25 basis points in February next year.
Recent data show that consumer vitality will support the US GDP in the fourth quarter and the first quarter of next year will remain on the expansion track, but the financial tightening caused by the subsequent interest rate hikes will make the economy a shallow recession.
Funds fleeing US stocks may face a test
As the Federal Reserve continues to release signals that it will slow down interest rate hikes in the future, the momentum for the rebound in US stocks has not failed.
In the eyes of optimistic investors, the market uncertainty brought about by interest rates is decreasing. The Chicago Board Options Exchange (CBOE) panic index (VIX) has gradually fallen since October 12, when the U.S. stock market hit a low of the year to 34.53. It has fallen to 19.06, a new low since April this year.
It is worth noting that the flow of funds shows the psychology of investors taking profits.
Concerns about economic growth resurfaced after U.S. stock funds posted a total outflow of $16.2 billion in the past week, the highest since April, according to data from financial data provider EPFR Global.
A report last week from the Cleveland Fed showed that the central bank has raised interest rates higher than would normally be required to follow monetary policy rules.
The latest quarterly interest rate forecast calculated by the Federal Reserve rules shows that the short-term interest rate target in the fourth quarter of this year should be 3.52%, which is lower than the current range of the federal funds rate of 3.75%-4.00%. Next, considering that the Fed’s interest rate hike cycle has not ended, Rising borrowing costs could further hit the economy.
Ipek Ozkardeskaya, senior analyst at Swissquote Bank, believes: "Strong economic data means that the Fed will continue its tightening policy and may target relatively higher final interest rates, which is not good for stock valuations. Therefore, the S&P 500 has limited room to rebound, which also coincides with the top of the year-to-date downward channel, which should mark the end of this bear market rally, and the index is expected to fall to around 3,400 next.”
Morgan Stanley chief equity strategist Mike Wilson, who is the most accurate Wall Street analyst in predicting the trend of U.S. stocks this year, also issued a warning that U.S. corporate performance will be revised downwards in the future and deal a heavy blow to U.S. stocks.
"The bear market is not over yet. If our earnings forecast is correct, U.S. stocks will continue to decline." Wilson predicted in the outlook, "The profits of U.S. stock companies will drop by 11% in the next year. By then, it will not only hurt the Pain will spread to more interest rate sensitive tech companies. Expect the S&P 500 to fall in the 3000-3300 range at some point in the first four months of next year. By then, we think earnings expectations The corrected acceleration of will peak."
Ethan Harris, an economist at Bank of America, said a recession could happen at any moment because all major U.S. economic indicators are either already in recessionary territory or have moved in that direction in recent months.
While the U.S. labor market continues to grow, he noted that the job growth trend over the past 12 months has been downward and, if sustained, will turn negative by the summer of 2023.
Bank of America remains bearish on the performance of risk assets in the first half of 2023.
At that point the narrative will change, from inflation and interest rate shocks to recession and credit shocks.
In terms of investment strategy, Bank of America believes that it will be long on bonds in the first half of the year to prepare for the risk of a hard landing, and long on stocks in the second half of the year. Risk appetite will improve after the Fed's policy peaks.