Dovish Fed

The Federal Reserve’s two-day meeting in 2023 ended with unchanged interest rates. However, indications of potential rate cuts in the coming year triggered significant gains in both stock and bond markets. The Federal Open Market Committee unanimously held rates steady between 5.25% and 5.50% signifying a notable shift in their approach, especially for 2024. But the quarterly “dot plot” suggested policymakers were considering three quarter-point cuts in 2024, a more accommodative stance than expected.

Powell’s insights

Powell acknowledged a potential peak in the current rate cycle, signaling a shift in focus towards preventing unemployment spikes. There are concerns that the Treasury rally may have occurred too swiftly. Furthermore deeper rate cuts might only happen if a rapidly slowing economy compels the Fed to intensify easing, contrary to the expected soft landing.

Big Tech consolidation

Big Tech has been resistant to a higher interest rate environment. But what happens when the fed funds rate goes down? Elevated interest rates pose “a somewhat greater challenge” for monetary policymakers. Lower interest rates lead to cheaper borrowing, which leads to more investment in growth. Big Tech companies with over $1 trillion market cap have deep pockets to materialize that growth and corner their respective markets. With that horizon in mind, Big Tech as well as disruptive tech companies could post new all-time highs next year.

Markets break out

The blue-chip Dow Jones Industrial Average closed up 2.93% and hit its first record closing high since January 2022, rising above the 37,000 level for the first time in history. The S&P 500 gained 2.5% and could soon join the Dow in record territory, as the benchmark index is less than 2% away from reaching its all-time close set in January of 2022. The tech-heavy Nasdaq Composite closed up 2.85% this week.

Yields go south

As Powell goes all-in for 2024, it seems either the Fed Reserve knows something we don’t know about the economy, or has convinced itself it can achieve a soft landing and is going all for it. The Fed expects the balance of its monetary policy to kick in. It wants financial conditions to ease to keep the economy from going into recession as those effects of tightening take effect. There is no other reason why the Fed would have decided to indicate cuts at this point. The rate-sensitive 2-year Treasury yield dropped below 4.4% and the benchmark 10-year yield dipped to 3.9%.

Dollar nosedives

The U.S. dollar witnessed a substantial decline, its most significant in two days since July, post the Federal Reserve recent policy meeting. This drop followed the Fed’s hint at potential interest rate cuts, prompting a shift in investor sentiment. The Dollar index plummeted below 102 and closed this week with a decline of 1.40%.

EUR/USD and GBP/USD

This decline wasn’t exclusive to the dollar but echoed across the currency market, especially as major central banks like the ECB and BOE maintained their current interest rates. This week, both the euro and pound sterling gained over 1% against the dollar, reflecting the market’s response to stable interest rates.

ECB’s dilemma

Despite steady rates, the ECB accelerated its exit from the Pandemic Emergency Purchase Programme (PEPP) bond-buying initiative, signaling a continued shift toward policy tightening amid decreasing inflation trends. Expectations for future ECB rate cuts have slightly decreased. The ECB emphasized its commitment to maintaining restrictive policy rates until meeting the inflation target, diverging from policy stances of the Federal Reserve and Bank of England.

Gold and Silver

Amid recent U.S. attempts to freeze gold assets held by certain nations, including Russia and Venezuela, the U.S. central bank and fiat currencies aren’t seen as secure havens. Despite central banks worldwide acquiring gold bullion for their reserves at record rates in recent years, individual investors haven’t shown substantial interest in buying bullion due to higher cash instrument rates and a thriving stock market. However, this trend could shift as the Fed leans towards rate cuts and a potential economic downturn in the coming year. Gold futures reflected the Federal Reserve’s dovish stance, hinting at anticipated interest rate cuts in 2024. The Fed’s efforts to maintain lower borrowing costs led to a decline in the U.S. dollar index to a four-month low, propelling gold futures to close the week at $2035, marking a 2% increase. Silver also experienced a 5% weekly gain, closing at $24.15 per ounce.

Copper’s luster

The future of copper is poised for a significant upswing amid the global shift towards renewable energy in emerging economies. The anticipated shortage in copper supply could exert upward pressure on prices, despite a temporary surplus expected through early 2024. The Fed’s dovish policy and its anticipated soft landing is also a reason for copper’s rally this week which resulted in gains of over 1.5%.

Oil

Oil prices climbed on Thursday, bolstered by a larger-than-anticipated drop in U.S. crude stockpiles and the dollar’s weakness following the dovish stance of the Fed. WTI crude futures held steady throughout the week, closing above $71.4 per barrel. Data from the EIA revealed a significant decrease in U.S. oil inventories. However, this draw contrasts with preceding weeks of substantial builds, hinting at a potential decline in winter demand.

Summary

The Fed’s potential shift toward interest rate cuts, aimed at addressing subdued inflation and a moderating global economy, has caused a ripple effect across both developed and emerging market currencies. The dollar’s decline serves as a clear signal of this evolving monetary landscape, prompting investors to adjust their expectations in response to fresh data and central bank guidance.

In 2023, the safety trade primarily centered around the S&P 500 basket. However, caution is warranted as the market dynamics shift. Areas that performed below expectations in 2023—such as bonds, small caps, and other rate-sensitive sectors—could potentially outshine in 2024. This shift may come at the expense of other sectors. The impact on indexes will largely hinge on the magnitude of this rotation.

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