Stocks and bonds had a strong week as Federal Reserve Chair Powell provided a more dovish outlook for interest rates. Interest rate and economically sensitive sectors such as banks saw a significant boost in response. The Magnificent 7 tech giants, including Microsoft, Meta Platforms, Amazon, Apple, NVIDIA, Alphabet, and Tesla, outperformed sharply last week. In addition to Powell’s comments, the 10-year and 2-year U.S. Treasury yields declined, causing the Bloomberg U.S. Aggregate Bond index to appreciate. Cyclicals also outperformed consumer staples by a wide margin.
The Fed decided to keep short-term interest rates unchanged at their recent meeting, with a mild dovish surprise in the form of maintaining the forecast for three interest rate cuts in 2023 despite higher inflation readings. Forecasts for PCE inflation and economic growth were revised higher, while jobless rate estimates were reduced. February consumer inflation was higher than expected at 3.2% year-over-year, with the supercore measure of services inflation holding steady at 4.3%. Powell emphasized the Fed’s progress towards its 2% inflation objective over time, noting that the inflation trend is lower despite fluctuations.
Powell stated that he did not attribute elevated inflation to higher wages, believing that labor market imbalances were mostly resolved and wage growth was moderating. He indicated that the Fed would be more inclined to cut rates in response to unexpected weakness in the job market rather than elevated inflation. Markets now anticipate an 85% chance of a Fed easing in June, up from 60% the previous week, with expectations for three rate cuts in 2024. Risk assets rose as the Fed’s sensitivity to economic weakness over inflation was seen as positive, reducing the likelihood of a recession.
The solid performance of economically sensitive stocks following the Fed meeting has led to a decrease in the probability of a recession, as the hurdle for the Fed to ease monetary conditions is perceived as lower. While Powell downplays the risk of wage growth impacting services inflation, it remains an area to monitor closely for potential issues. The upcoming holiday-shortened trading week is not expected to have any major market-moving releases, but several Fed speakers are scheduled, which could provide further insights into the central bank’s future plans and their impact on the markets. Overall, the markets are reacting positively to the Fed’s dovish stance and the potential for rate cuts in the future.
