The Fed's decision has reignited bullish enthusiasm. Is there no resistance to the market at the end of the year?

After the Federal Reserve announced its last resolution of the year, U.S. stocks ushered in a new round of buying, pushing the three major stock indexes to rise for seven consecutive weeks, with the Dow hitting record highs for three consecutive trading days. Investors' optimism about interest rate cuts has further weighed on U.S. bond yields and boosted market sentiment.

As this year's market comes to an end, factors such as year-end seasonal effects may continue to attract more OTC funds to enter the market. However, the game of interest rate expectations may become a risk factor for short-term shocks.

Fed looks forward to cutting interest rates

After keeping interest rates unchanged for three consecutive times at the end of the year, the Federal Reserve ended the year's meeting agenda with a slightly dovish attitude. While leaving open the possibility of further action, Fed Chairman Jerome Powell said monetary policy tightening may be over and discussions of rate cuts are on the horizon.

The Federal Reserve's latest economic forecasts show that it is making better progress in its dual mandate of inflation and employment. The Federal Open Market Committee (FOMC) slightly revised down its price and economic forecasts for next year, but does not expect significant fluctuations in the labor market. The most eye-catching thing is that the median interest rate at the end of next year will drop to 4.6%, 50 basis points lower than in September, which means that the potential space for interest rate cuts will increase from 2 to 3 times.

Bob Schwartz, senior economist at Oxford Economics, said in an interview with China Business News that as the Fed believes that the two-way risks of policy are becoming more and more balanced, communication about the direction of interest rates is obviously no longer so tough. "Although the possibility of further interest rate hikes has not been completely eliminated, regardless of the outlook or Powell's statement, the next adjustment will be to cut interest rates."

Federal funds rate futures show that the market expects the possibility of a 25 basis point cut in March next year to have risen to about 70%. A summary of China Business News found that institutions have obvious differences in their speculations on the scope for interest rate cuts next year, ranging from 2 to 7 times. Mid- and long-term U.S. bond yields fell sharply. The 2-year U.S. bond, which is closely related to interest rate expectations, fell 27 basis points to 4.55%. The benchmark 10-year U.S. bond fell nearly 32 basis points to 3.93%, the largest since October last year. fell and hit a six-month low.

Economic resilience may be a hindrance to the Fed's shift. Although the manufacturing industry is still at a sluggish level, data released last week showed that the U.S. Composite Purchasing Managers Index (PMI) stabilized and rebounded in December. It is worth noting that consumer spending remains strong. U.S. retail sales increased by 0.3% month-on-month in November, which was better than market expectations. The vitality of the holiday season also alleviated concerns about a sharp economic slowdown in the fourth quarter. At the same time, the job market remains stable and the number of initial jobless claims has returned to the 200,000 mark. These factors may allow the Fed to remain patient and wait for inflation to gradually fall back to its 2% target.

"Consumer resilience provides credibility for the Fed to achieve a soft landing, but also sends a signal that the Fed is unlikely to do what the market is now pricing in," said Kathy Bostjancic, chief economist at Nationwide. Cut rates that quickly. The stronger economic activity, the slower inflation will fall and the slower the Fed will respond with rate cuts."

It is worth mentioning that in their speeches after the resolution, two Fed officials "cooled down" the possibility of cutting interest rates early next year. New York Fed President Williams told the US media that it is too early to discuss whether to adjust borrowing costs. "We are not talking about cutting interest rates now." Dovish member and Atlanta Fed President Bostic revealed that he thinks the Fed Rate cuts could begin as early as the third quarter of 2024.

Schwartz told China Business News that the Fed seems to be considering cutting interest rates when the core PCE inflation rate is close to 2% rather than reaching 2%. “To achieve this, the Fed needs to see a significant slowdown in economic growth to ensure that inflation Stay on the downward track." He believes that this growth slowdown is happening, and the labor market is expected to continue to loosen, and high interest rates will eventually drag down consumer spending growth in 2024.

Schwartz reiterated his previous view that the market's expectations for interest rate cuts in the first half of the year are too optimistic. "If the economic data performs stronger, the interest rate vision will easily be revised upward." He predicts that the Federal Reserve will only cut interest rates twice next year. The first The time will be in the third quarter.

Investors look forward to year-end market trends

As interest rate cuts began to enter the Federal Reserve's horizon, U.S. stocks started a new round of gains in the second half of last week, with the three major stock indexes all rising more than 2% for the week. The Dow Jones Industrial Average broke through the 37,000-point milestone for the first time. The next one that is expected to set a new record may be the S&P 500 Index, which is only 1.6% away from its January 2022 high.

The loosening vision of monetary policy has led many market participants to believe that the market that started in late October is not over yet. History shows that interest rate cuts are often an important prerequisite for stock market gains. Matt Weller, global head of research at City Index, said in a market commentary that it is rare for the index to have seven consecutive positive weeks, but this usually occurs in the middle of a long-term bull market.

Ameriprise Financial chief economist Russell Price believes that the market's more optimistic tone in the past few weeks is reasonable. "Looking at the direction of the stock market, investors are quite fully pricing in the Federal Reserve's interest rate cut in 2024, and the recent decline in the 10-year Treasury bond yield has helped boost risk appetite." He said.

The flow of funds shows that after investors expect that the current tightening cycle of the Federal Reserve has ended, funds have begun to flow back into U.S. stocks. Statistics from the London Stock Exchange (LSEG) found that U.S. stock funds received a net purchase of US$1.98 billion last week, with large-cap stocks gaining favor. At the same time, money market funds, reflecting cautious sentiments, recorded their first net outflow in nearly eight weeks, reaching $16.68 billion.

With contracts such as more than $5 trillion in stocks, exchange-traded funds, and index-linked options expiring on Friday, investors will begin to prepare for the market at the end of the year and next year.

Charles Schwab wrote in a market outlook report that U.S. stocks continued to rebound as the Federal Reserve signaled a policy shift to the outside world. The question now is whether investors are too optimistic about the vision of a soft landing and the potential for earnings growth next year, the report believes. Another potential concern is that the Fed may at some point change its view on markets given that inflation remains stickier than expected given the recent relief in financial conditions.

The agency believes that technically, the stock index is still under the control of bulls, market breadth is increasing, and monetary policy vision and seasonal factors are still biased toward a bull market. In the short term, however, the rally may have gone a little too far, too fast, and U.S. stocks may re-enter a tight range in the coming week. While digesting policy expectations, the market will trade sideways or continue to fluctuate upward. In the medium term, the market environment is conducive to a bull market, but repairs in technical indicators may mean that the market needs some downtime.