The Fed expects it won't be able to cut interest rates three times in 2024 until March. The financial markets agreed. But the data that has since emerged suggests that everyone sings a different song. This week's data was more of an afterthought compared to last week's.
The chart above refers to the Fed's interest rate expectations, and these are not exactly the same as longer-term interest rates such as mortgages and 10-year Treasury yields. The latter experienced a bit more volatility this week.
Monday's retail sales were much stronger than expected and markets reacted immediately. Tuesday's data was significant, but it was followed by a speech in which Fed Chairman Powell had the opportunity to offer some updated thoughts on the interest rate outlook. After all, the Fed had not yet seen the latest CPI data (and several other strong reports) when the latest round of interest rate forecasts came out in March.
As expected by the market, the tone is evolving. While Powell and the Fed reiterate that interest rate trends depend on economic data, it is no surprise that recent comments acknowledge surprising strength in recent data. Stronger data means fewer rate cuts. Powell even went so far as to say that there is new uncertainty about whether the Fed will even be able to cut interest rates in 2024.
Two days later, New York Fed President John Williams struck a similar tone. Just last week, he pushed back on the CPI data, saying the Fed was not surprised by setbacks in inflation data. This week's comments did more to acknowledge the other side of data dependency. Specifically, Williams said the Fed could raise rates again if the data warrants it.
Certainly these are not earth-shattering “ifs” and “thens.” But the market is paying attention to the subtle differences used to communicate data dependency. It didn't help that the Philly Fed Manufacturing Index rose to its highest level in two years on Thursday morning, or that the “prices paid” component of the same report rose much more than economists had expected.
Here's what the entire week looked like in terms of 10-year Treasury yields.
Friday's reaction to the attacks in Iran is important because it shows us that some geopolitical news is actually worth reacting to. That was less clear earlier in the week, as several shots of reasonably similar headlines didn't generate as much movement. The difference on Friday was uncertainty over the state of Iran's nuclear sites and concerns that it could be the catalyst for the outbreak of far more serious fighting. The market calmed down quite quickly as it became clear that the nuclear facilities were not damaged and Iran would not retaliate. The correlation between stock prices and bond yields further confirms the “flight to safety” trading pattern often observed following such news.
Overall, the last two weeks have done much to make the end of 2023 look like another “false start” toward lower rates. Until then we had a bit of a fighting chance. Although we have called the end of 2023 the third false start of this cycle, by its purest definition it would not be until interest rates rise back above last October's highs. We're definitely not there yet, and we won't know if we're getting there until we see the next round of key economic data in May.
Meanwhile, home sales remain subdued.
Aside from Friday's PCE price index, next week's economic data will be muted. This is not as big of a market mover as the Consumer Price Index (CPI), but could certainly cause some volatility if it conveys a different message.
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