There’s a fantastic song by the great Matt Nathanson that I’ve always loved called, “Come On Get Higher.” Here’s an acoustic version of the song from a 2013 appearance at Amoeba Records in San Francisco, where coincidentally, your editor happened to be that day. Now, I bring up this song title today because it reminds me of what the market is facing right now, and that is the headwind that is “higher-for-longer” interest rates.
As we wrote this morning in the daily market briefing, Eagle Eye Opener (which you simply must subscribe to, if you want to know what real professionals are watching each trading day), the recent stall in the stock market rally has coincided with a quiet, but important, evolution in the outlook for Federal Reserve monetary policy, as investors have started to focus on what’s “next” from the Fed, namely rate cuts. And over the past two weeks, rate cut expectations have been solidly pushed out, and that’s contributing to the upward pressure on yields and a growing headwind on stocks.
Now, we understand that it might seem somewhat premature for the market to be focused on when the Fed cuts rates, considering we may get another rate hike before year-end. But that’s just testament to the reality that the market is always looking for what’s “next,” and with the Fed done (or almost done) with rate hikes, what’s “next” is rate cuts.
Broadly speaking, investors had previously anticipated a rate cut as early as March 2024. But over the past month, that’s been pushed out to May and that has contributed to the rise in the 10-year yield and the headwind on stocks, because the longer it takes for the Fed to cut rates, the greater the chances of a hard economic landing, and the reason is clear: The longer rates stay high, the more pressure on the economy, and the greater likelihood that an economic contraction occurs.
Going forward, it’s not so much about how high rates go (barring a major surprise of two or more rate hikes), but instead how long they stay high.
That’s also why 2024 year-end fed funds estimates have become important. Right now, markets expect year-end 2024 fed funds to end at 4.33%. That reflects 100 basis points of rate cuts in 2024 (starting in early 2024). Here’s the problem: That is fewer cuts than the market expected a month ago.
One month ago, the market was pricing in a year-end fed funds of around 4.10%, or another 25 basis points of cuts next year. Now, that number has drifted higher thanks to solid economic growth and a lack of a big decline in inflation. So, why does this matter to you?
It matters, because if the market pushes out the timing of the first rate hike (June or beyond) or increases the expectations for year-end 2024 fed funds (meaning there will be fewer cuts next year) then that will act as a hawkish headwind on stocks and boost Treasury yields further (10-year Treasury yield above 5%?) and that, in turn, will increase hard landing chances and weigh on stocks.
Because of this reality, and until the market dynamic changes and this is no longer necessary, our Eagle Eye Opener will include commentary on the data so you know 1) At what point markets expect the first rate cut, and 2) Year-end 2024 fed funds expectations.
That way, we can see whether the market expectation is becoming more hawkish (negative for stocks and bonds), because if the market begins to price in a higher-for-longer interest rate environment, that will be a new and substantial headwind on stocks — and that would require getting more defensive in portfolio allocations.
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Betting with A French Novelist
“Often the difference between a successful person and a failure is not one’s better abilities or ideas, but the courage that one has to bet on one’s ideas, to take a calculated risk — and to act.”
— Andre Malraux
If you know me, you know that my family’s heritage (on my father’s side) can be traced back to France. In fact, my last name “Woods” is a translation from the French word “DuBois,” which means “of the woods.” Now, my penchant for French literature (Hugo, Proust, Voltaire, Dumas, Verne) could be related to my heritage, but it also could be because many of these writers had a flare for language, deep ideas, and for living the “Renaissance Man ethos,” including the novelist and statesman Andre Malraux, who provides this week’s quote.
You see, when it comes to success in life, and certainly in investing, courage and the willingness to take action are two of your greatest weapons. Hey, leave it to a fellow Frenchman to sing that point home!
Wisdom about money, investing and life can be found anywhere. If you have a good quote that you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my newsletters, seminars or anything else. Click here to ask Jim.
In the name of the best within us,
Jim Woods
