Balancing an Improving Outlook with 2024 Q1 Headwinds
Photo Credit: Jasmin Ne, Unsplash
Analyzing Market Expectations for 2024
Stocks and bonds rallied in Q4 as the headwinds from Q3 dissipated. The rally started in early November when the Treasury’s Quarterly Refunding Announcement (QRA) favored issuing Treasury bills over Treasury bonds. The QRA provided relief to bonds, particularly long-duration bonds, as Treasury yields declined and erased most of their Q3 rise. In December, the Fed’s FOMC meeting triggered another rally as the Fed’s dovishness and updated Summary of Economic Projections surprised the market. Treasury yields took another leg lower as the Fed endorsed the prospect of 2024 interest rate cuts, with stocks and bonds once again trading higher.
Market Fed Funds Rate Forecast vs Actual
Number of Months Between Final Rate Hike and First Rate Cut
Are Markets Priced for Perfection in the Near Term?
The following is a list of the expectations we currently see priced into financial markets.
Investors expect the Fed to cut rates by more than -1.25% in 2024, starting in March.
The US economy is forecast to grow below-trend as higher interest rates slow activity, and inflation is expected to settle around the Fed's 2% target.
The pairing indicates that the market expects a soft landing.
S&P 500 earnings are forecast to grow over 10% in 2024 as sales growth drives profit margin expansion.
The high-yield credit spread is tight compared to history, indicating investors are not worried about credit risk.
Is the Consensus Wrong?
The above expectations are already priced into stocks and bonds. We believe the number of forecasted interest rate cuts is too aggressive given current labor market dynamics and underlying economic resilience. While we expect rate cuts in 2024, the Fed will take a more measured approach, like the -0.75% of proactive cuts in 1995 and 2019. Current credit spread levels leave little margin for error despite the historical lag of monetary policy and banks tightening lending standards. While we do not expect credit spreads to blow out, the high-yield credit spread is tight compared to history. The corporate earnings are too optimistic considering that falling inflation, which historically leads to slower sales growth, suggests profit margins could come under pressure. However, our S&P 500 Earnings Indicator is trending higher, indicating that the earnings outlook is improving.
Potential Headwinds for 2024
The year-end rally may extend into early January, but potential headwinds loom in 2024 Q1. Seasonality, a tailwind in Q4, is historically a headwind early in presidential election years. The Treasury QRA, scheduled for January 31st, could cause Treasury yields to reverse higher, with Secretary Yellen likely to increase Treasury bond issuance due to internal Treasury guidelines that specify the ratio of bonds to bills. The Q1 headwinds stem from the market's optimistic rate-cut forecast and exuberance rather than an economic slowdown.
US Election Year Seasonality
Putting It All Together
At the same time, today's easing financial conditions lay the groundwork for a potential economic rebound in 2Q24 and beyond—a trend evident across our indicators. As the calendar turns, the financial markets' twists and turns look set to continue in early 2024.
Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.
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