What’s Driving Stocks to New All-Time Highs? Fed Watch and Recession Odds

By Victor Sperandeo with the Curmudgeon


The S&P 500, Nasdaq 100, and DJI all closed at record new highs on Friday January 19th.  The U.S. equity markets have been driven higher the last few months by anticipation of as many as six interest-rate cuts this year, yet the Fed has forecast only three.  In fact, several Fed officials this week tried to tamper down expectations of a rate cut in March (more below). 

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Meanwhile, intermediate, and long-term interest rates have risen this year. The yield on the 10-year U.S. Treasury Note—a benchmark for borrowing costs from mortgages to corporate loans—rose to 4.145% on Friday, after starting the year at 3.860%. See Victor’s market comments below for more.

Also, there’s been continued pressure on the U.S. housing market, which often leads the economy. Existing home sales, which make up most of the housing market, slid 19% in 2023 from the prior year to 4.09 million, the lowest full-year level since 1995, the National Association of Realtors reported.

Fed Funds Watch:

In December, the Fed said there would likely be three rate cuts in 2024.  Last week, there was a better than 70% chance rates would be cut by a quarter percentage point in March, according to the CME Fed Watch Tool.  As of this writing (Jan 21, 2024) that number is 46.2%, with 52.9% forecasting no rate cut in March.  As noted in the Introduction above, there were several cautious rate cut comments by Fed officials last week:

·        Federal Reserve Governor Christopher Waller acknowledged Tuesday that Fed interest rate cuts are likely this year, but said the central bank should take its time relaxing monetary policy. “When the time is right to begin lowering rates, I believe it can and should be lowered methodically and carefully,” he added. “In many previous cycles ... the FOMC cut rates reactively and did so quickly and often by large amounts. This cycle, however, I see no reason to move as quickly or cut as rapidly as in the past.”

·        On Thursday, Atlanta Federal Reserve President (and FOMC voting member) Raphael Bostic said he expects policymakers to start cutting rates in the third quarter of this year.  Bostic said he’s not dead set against cutting earlier than the third quarter, implying a move in July at the earliest, but said the bar will be high.

·        Chicago Federal Reserve President Austan Goolsbee on Friday declined to say when he thinks the central bank will cut interest rates, but he said reductions could be expected this year “if we continue to make surprising progress on inflation. We don’t want to commit ourselves before the job is done,” Goolsbee said in an interview on CNBC.  “As inflation comes down, that opens the door to a reduction in restrictiveness.”

The current Fed Funds target rate is 500-525 bps (5.0-to-5.25%). By the end of 2024, the CME Fed Watch tool assigns a 33.6% probability of the Fed Funds target rate at 400-425 bps, a 33% chance of it being 375-400 bps, and 16.3% at 425-450 bps.

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What’s Driving Stocks Higher?

Some pundits attribute this week’s rally to improving corporate earnings reports, which “took the leash off the bull,” according to Jeff Kilburg, founder and CEO of KKM Financial. “All we needed was a spark to get the S&P 500 back into positive territory.”  Others are skeptical.  “The market is still looking for proof to justify the rally over the past three months,” said Scott Duba, chief investment officer at Prime Capital Investment Advisors.

“Clearly, the consensus is that inflation is under control and we’re heading for a soft landing,” said Doug Fincher, a portfolio manager at New York City-based hedge fund Ionic Capital Management. “It’s certainly possible—but a lot of that is priced in (the equity markets).”

Victor has a different opinion.  He says the impetus for stock indexes making all time new highs this week was a January 6th speech by Dallas Fed President Lorie Logan.  She explained how contracting liquidity in money markets may prompt the Fed to reduce its rate of Quantitative Tightening (QT): 

"In my view, we should slow the pace of runoff (QT) as ON RRP (Reverse Repo) balances approach a low level,” Logan said. “Normalizing the balance sheet more slowly can actually help get to a more efficient balance sheet in the long run" by making it easier for financial firms to adjust their individual liquidity levels, she added and noted that there are signs liquidity is getting tighter for banks.

Victor thinks it’s too early to allow financial easing because it has to be tied to the November U.S. elections. The Democrats dominate the FOMC committee and desperately want to help their party candidates win elections in 2024.

Victor on the Markets:

As previously stated, I believe stocks are a new form of savings accounts, especially the Magnificent Seven, and that valuations are no longer relevant.

To reinforce that equity valuations are “out the window,” note that Germany’s DAX stock index hit an all-time high on 12/13/23 at 16,794.43 while the country is in a 2-year recession due to higher energy costs and weaker industrial demand.  The German national statistics office said “multiple crises” affecting the economy had contributed to a 0.3% fall in gross domestic product (GDP) in 2023, compared with the previous year, as higher interest rates and elevated living costs took their toll.

Bonds will be subject to rising inflation pressures due to huge deficit spending by the U.S. federal government.  For example, TLT iShares 20+ Year Treasury Bond ETF has recently declined 6.69% from 100.51 on 12/27/23 to 94.09 on 1/19/24 (with a low of 93.79 on 1/18/24).

Meanwhile, June Gold Futures declined only -1.68% from its recent high on 12/28/23 to Friday’s close.

I am bullish on stocks and gold, neutral on commodities (due to China’s economic weakness), and short term bearish on long duration bonds.

Recession in 2024?

Real U.S. GDP is now estimated at +2.4% (annualized) by the Atlanta Fed GDP Now tool for the 4th quarter of 2023.  That’s higher than the Blue-Chip consensus as shown in this chart:

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Overwhelmingly, economic experts and executives privately said they don’t expect a U.S. recession in 2024. The Fed’s potential interest rate cuts in the coming months, combined with rising consumer confidence, have led to optimism about the health of the economy – barring another major geopolitical crisis.

Yet one large brokerage and mutual fund firm is bearish on the U.S. economy.  Vanguard forecasts full-year 2024 real (inflation-adjusted) U.S. GDP growth of 0.25%–0.75% and a year-end unemployment rate of 4.8%, higher than the 4.1% envisioned in the Fed’s SEP.

For a recession to occur in 2024 (a U.S. election year), we’d have to have negative real GDP for both the 1st and 2nd quarters, sticky inflation, a huge drop in consumer spending and a rising unemployment rate.  That does not appear likely!

Curmudgeon Comments:

The big economic risk is geopolitical fallout from the widening war in the Middle East.  Also, the war in Ukraine if it expanded to Eastern Europe.

Also, there’s a huge potential risk if the Fed doesn’t lower rates as much as the markets expect.

“People tried to front-run the rate cuts by buying long-duration assets, like tech stocks and bonds,” said Nancy Davis, founder of asset management firm Quadratic Capital Management. “What if the Fed doesn’t cut that much or that quickly? Those people get hung out to dry.”

Victor’s Conclusions:

Expect bullish Fed talk AFTER the March or May 1st FOMC meeting to make things look good going into the November elections.  I believe that the markets have all this figured out. It is the forecasters that are bearish on the economy, not the markets.  U.S. government deficit spending (and increased national debt) helps stocks but hurts bonds.

End Quote:

“Liberty may be endangered by the abuse of liberty, but also by the abuse of power.  The essence of Government is power; and power, lodged as it must be in human hands, will ever be liable to abuse.”

James Madison was an American statesman, diplomat, and Founding Father who served as the fourth president of the United States from 1809 to 1817. Madison was popularly acclaimed the "Father of the Constitution" for his pivotal role in drafting and promoting the Constitution of the United States and the Bill of Rights. 


Success, good health, and good luck.  Till next time………………………………………….

The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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