The Fed’s Holiday Surprise

Weekly Commentary

Market Recap

• Equity markets rallied this week as markets priced in early-and-often rate cuts for 2024.
• The S&P 500 rose 2.5%, led by banks and cyclicals (materials, industrials and consumer discretionary), while the Dow pushed to a record high.
• The TSX gained 1.0% with banks jumping almost 4% on the week.

The Fed

Last week, the U.S. Federal Reserve (Fed) released projections indicating that it expects at least three 25-basis-point interest rate cuts by this time next year. Meanwhile, economic data seems to be confirming that inflation is retreating. Needless to say, these are positive developments. It’s important to note, however, that this good news on interest rates is not the result of a badly hurt economy—if that were the case, then our reaction to potential cuts would be much more bearish. The Fed’s statements confirm our long-held belief that the Fed is likely to ease rates in 2024, though we remain reluctant to project cuts in the first half of the year; cuts in the second half are more likely in our view. If that is the case, then markets would be wise to temper their optimism somewhat and price in the chance that rates won’t be lowered as quickly as some are expecting. That being said, this news gives markets a chance to move higher (as we had called in November) as we approach the end of the year and carry forward the recent momentum in both equities and bonds.

Bottom Line: The Fed’s statement regarding likely interest rate cuts in 2024 is good news for markets, though these decreases may not materialize as soon as some investors are hoping.

Gold

Gold has been on a bit of a run lately, with prices topping $2,000 USD per ounce again. With some analysts projecting it to soar past $2,200/oz by the end of 2024, is now the time to be adding gold to portfolios? We wouldn’t go that far. But if you do have a position in gold, we believe it makes sense to hold on to it. As we enter the new year, gold serves as valuable protection against various risks—for instance, if the economy declines more than anticipated, if inflation spikes back up, if interest rates remain higher for longer, or if markets sell off after the strong run we have had. Gold served that defensive purpose well during the market downturn in September and October, and that’s why we continue to have a slight overweight to gold in our portfolios.

Bottom Line: We remain slightly bullish on gold, but view it as more of a defensive play than an offensive one.

Macro Drivers

Which macroeconomic drivers will we be watching most closely in 2024? Number one is the consumer and, by extension, unemployment. Greater consumer debt levels—and the rising cost of servicing that debt—is likely to bring some people back into the work force. But for people who already have a job, we’ll be looking for any significant changes—for instance, whether unemployment increases or holds steady. If more people lose their jobs, then that would be a sign that cracks in the economy are stating to worsen; after all, if you lose your job, you generally don’t spend much at all, whereas if your income isn’t growing but you’re still employed, you’ll continue to spend. In general, we’d like to see the economy avoid greater job losses in 2024. The second thing we’ll be watching is consumer preferences—how quickly are people moving away from high-priced items, and are they trading down to medium-priced goods or lower-priced staples? So far, we’ve seen a minor shift but nothing massive, which tells us that consumer health may continue to be okay. The third driver we’ll be watching is mortgage rates. In both Canada and the U.S., mortgage rates have been high, but we’re starting to see them come off a bit as central banks pivot to likely rate cuts. That should provide some measure of relief for homeowners whose mortgages are coming up for renewal. Finally, we’ll be monitoring the overall health of the economy. If it weakens more than expected and rate cuts are pushed out, that could indicate a real problem. Of course, we can’t forget about geopolitical risks as well, particularly with the U.S. elections coming up in 2024.

Bottom Line: The most important macroeconomic driver we’ll be monitoring in 2024 is the consumer, and we’ll also be keeping an eye on mortgage rates and the economy in general.

Positioning

In terms of positioning, we’re closely monitoring the rebound we’re stating to see in Financials. We’ve been optimistic about banks for some time, and we continue to see potential upside given the Fed’s recent pivot. How we’d like to play that sector will be a big part of our discussions as we enter the new year.

For a detailed look at the forces that may shape markets in 2024, check out the special December issue of the BMO GAM House View Report, titled 10 Big Investment Trends for 2024.

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Originally Posted December 18, 2023 – The Fed’s Holiday Surprise

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