The Federal Reserve’s decision

Following its concluding two-day meeting in 2023, the Federal Reserve opted to maintain the current interest rates unchanged. Despite this decision, officials hinted at potential rate cuts in the upcoming year, resulting in a significant upsurge in both stock and bond markets. This indicated a significant shift in their approach, particularly for 2024.

Fed’s future outlook

The Federal Open Market Committee’s unanimous vote maintained the rates within the range of 5.25% to 5.50% on Wednesday. However, the quarterly “dot plot” unveiled by the U.S. central bank outlined future rate expectations. Notably, policymakers were contemplating three quarter-point cuts in 2024, signifying a more accommodative stance than previously estimated.

Insights from Jerome Powell

In the aftermath of this decision, Fed Chair Jerome Powell acknowledged a likelihood of being at or near the peak rate for the current cycle. Powell noted the Fed’s aggressive rate hikes to counter elevated inflation and expressed the intention to shift focus towards preventing a spike in unemployment. While not entirely content with the current pace of price growth, the Fed is seemingly looking to avert potential economic downturns due to a restrictive policy stance.

Market reaction

U.S. stock and US government bonds surged significantly after prompted by the Fed’s projected rate cuts. Major indices like Dow Jones and S&P 500 raced to record highs at closing. Correspondingly, U.S. Treasury yields dropped, influencing prices inversely. A far more hawkish Fed had been anticipated.

Currency and precious metals

The dollar weakened to a four-month low, reflecting market expectations of imminent rate cuts by the Fed in early 2024. This sentiment drove the dollar index down to 102.6. Simultaneously, gold prices surged beyond $2,000 per troy ounce as the weakened dollar made gold more affordable for foreign buyers.

Central Bank actions in Europe

Several European central banks are set to reveal their latest interest rate decisions. The Bank of England and the European Central Bank are anticipated to maintain rates at 5.25% and 4.00%, respectively. Observers are curious about their stance regarding rate cuts.

Market outlook and expectations

The unexpected dovish turn from the Federal Reserve stimulated a rally in Treasuries, leading to historically low benchmark 10-year yields. The tumble in Treasury yields has rippled far beyond the bond market as it pulled down rates on mortgages, eased financial conditions and pushed investors into stocks and other risky investments.

More bad news is good news

Some investors anticipate difficulty in further bond gains without a substantial economic slowdown. Much of the dovish shift from the Federal Reserve may already be reflected in Treasury prices. Deeper rate cuts may only occur if a rapidly slowing economy forces the Fed to intensify easing, contrary to the envisaged “soft landing”. The rally in Treasuries seems overdone and too fast.

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