Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Fed has a final chance to pushback on rate cut expectations
Charu Chanana
Chief Investment Strategist
Summary: The US inflation was a mixed bag, as headline and core prints rising month-on-month but headline YoY came down and core YoY was unchanged. Details and long run trends suggest disinflation continues, but today’s announcement may be the Fed’s final chance to push back on market’s rate cut pricing. We consider three scenarios for Fed’s 2024 dot plot and the market impact that could bring.
Thoughts on US inflation report
US November CPI was a mixed bag. Headline CPI came in above expectations at 0.1% MoM vs. flat previous and expected, while the YoY cooled to 3.1% from 3.2% previously. Core measure was as-expected at 0.3% MoM (prev: 0.2%) and 4.0% YoY (prev: 4.0%).
While some could say the disinflation has made further progress (as headline YoY was down), others could say that core is rather sticky at 4% YoY.
The breakdown suggests that the cooling in core goods inflation is broadening, which suggests that the decline could be sustainable. Core services was a key problem area, and it appears that only a few categories, particularly shelter, drove much of the upside. Long run trends continue to suggest that the disinflation momentum is extending. Meanwhile, with oil prices near their recent floor of sub-$70/barrel for WTI, there will be little reason for the Fed to panic about anything seen in the latest inflation report.
What to expect from the Fed?
The December meeting is the Fed’s last chance to pushback on rate cut expectations. It remains clear that the rate hike cycle has ended, and investors are now focused on when the rate cuts could begin. That will make the dot plot very relevant today, although the ability of the dot plot to predict the future has been poor.
The September dot plot, as shown above, had a median 2023 projection of 5.6% as another rate hike was in the forecast. That will be removed and 2023 dot will be at 5.4% now. As for 2024, there are three scenarios:
- Sept dot plot showed a median projection of 5.1% for 2024. If that is maintained, that will now mean just one 25bps rate cut in 2024. This is a low probability outcome, but will serve as a massive pushback on market’s rate cut expectations for next year.
- Bonds: Yields likely to go up
- Equities: Could be bearish, especially the interest rate sensitive stocks
- FX: Dollar will likely strengthen, and EUR, AUD, NZD and Gold may have the most room to lose
- If the Fed maintains 50bps of rate cuts in its 2024 projections, that will mean the media 2024 dot shifts lower to 4.9%. This is the most likely outcome and it could see the current soft landing expectations getting extended.
- Bonds: Yields still likely to go up as markets have priced in far more rate cuts
- Equities: Likely to be sideways-to-higher as the current momentum is extended
- FX: Dollar could be mixed or somewhat lower, but a relative ECB dovishness on Thursday could bring back dollar gains
- If the fed adds even one more rate cut to its projection to expect 75bps rate cuts for next year, bringing the median dot to 4.6% or lower, that could have significant implications for the market. Again, this may be a low probability outcome as growth and labor data is still resilient.
- Bonds: Yields are likely to fall
- Equities: Could potentially rise, especially NASDAQ 100 or the tech stocks
- FX: Dollar will be bearish, which could bring potential gains in JPY, NZD, GBP and Gold.
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