Market Pulse: Bull Market Time
In 5 minutes, understand why yesterday's pivotal Fed meeting signaled the start of the next bull market, barring black swans.
In 5 minutes, understand why yesterday’s pivotal Fed meeting signaled the start of the next bull market, barring black swans.
Yesterday, the markets roared upwards after the Federal Reserve held its December FOMC press conference.
Why?
Because the Fed has finally acknowledged that inflation might be cooling for good after very defensive messaging in previous press conferences. In addition, the Fed signaled that they’re not just going to stopping rate hikes, they’re on the cusp of cutting them starting next year.
In many ways, the Fed is forced to cut rates given the tenuous fiscal situation of the US government. If rates remain high, the US government’s debt burden is set to explode in the next few years as the government has to refinance vast swathes of maturing debt and fund a massive and growing deficit, all at historically high rates. This could result in a catastrophic debt spiral.
The only thing standing in the way of the Fed cutting rates is inflation, and inflation is rapidly cooling. This gives the Fed an open field to cut and they’re signalling at least 3 cuts next year. Falling interest rates is great for the economy but they usually happen when the economy is in trouble. The Fed cutting rates without an ongoing recession is the Goldilocks economic outcome the bulls have been hoping for, and we might just get it.
No wonder the market is celebrating.
Cooling inflation is driven in large part by collapsing energy prices ($95 a barrel of WTI crude in September to under $70 now) and a normalization of trade relations with China (except for the semi industry). Energy prices are the primary driver of short-term inflation and the US government has been working behind the scenes to keep prices down, even if that means turning a blind eye on Russian oil flooding global markets.
It’s been widely reported that Russia has created a shadow fleet of oil tankers that are circumventing sanctions to export its oil. Bloomberg even published an exposé on YouTube with reporters filming two oil tankers illegally laundering Russian oil by transferring the oil from one tanker to another in the Gulf of Laconia just off the Greco coast. The shadow fleet’s illicit activities to sidestep US sanctions on Russian oil have been extensively reported over the last year but little is being done to stop it. For the moment, it’s too beneficial for the economies of the major parties involved (US, Europe, and Russia) to stop the flow of Russian oil into global markets.
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The Details
Cooling Inflation
Inflation is falling, and it’s falling hard. The Fed’s target inflation rate is 2% and November’s CPI fell to a comfortable 3.1%. All the while, leading inflation indicators like the job market and energy prices have also been cooling. Energy prices have been hit especially hard this fall and they’re a major contributor to prices throughout the economy. This increases confidence that inflation will continue to fall heading into next year.
Why Is Cooling Inflation So Important?
The Fed considers inflation one of the most important threats to the US economy. Once it emerges, it can be very persistent and difficult to reverse. The Fed’s primary inflation-fighting tool is raising interest rates, but high interest rates also hurt the economy, albeit in a way that’s much easier to fix.
As most of us know, the US economy experienced a severe bout of inflation in the past two years which has forced the Fed to rapidly raise rates and keep them high. With inflation cooling, the Fed now has the option to drop rates and this is sorely needed as the US government is drowning in debt and unable to shrink the deficit with two foreign proxy wars going on.
The economy gets boosted when rates fall and that’s what the market is cheering for.
The Fed Dot Plot
The Fed dot plot shows the estimates of top Fed policymakers for interest rates at the end of the next several years and over the long run. The forecasts are represented by dots arranged along a vertical scale — one dot for each of the Federal Open Market Committee members.
Each Fed meeting, a new dot plot is released. Yesterday’s dot plot showed that no Fed policymaker wants to raise rates next year and more than half think there should be at least 3 rate cuts instead. That’s a lot of rate cuts, and a significant shift from the Fed’s hawkish tone earlier in the year.
What could go wrong?
The market is rising on anticipation of the Fed cutting rates next year but we’re still far from that actually happening. The biggest risk to the rate cut narrative in 2024 is rising inflation, and this could be triggered by worsening tensions between the US and China or unexpected escalations in the Eastern European and Middle Eastern conflicts. In addition, if the conflicts intensify, the US government may be forced to issue significantly more debt than expected to finance the conflicts which pushes long-term rates up.
For now, the horizon appears to be clear.
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