Last week, stocks and bonds saw a significant rise as Federal Reserve Chair Powell provided a more dovish outlook for interest rates. Sectors like banks, which are interest rate and economically sensitive, received a substantial boost. The Magnificent 7 tech stocks, including Microsoft, Meta Platforms, Amazon, Apple, NVIDIA, Alphabet, and Tesla, outperformed sharply during the week.
Following Powell’s comments, the 10-year and 2-year U.S. Treasury yields declined to 4.2% and 4.6%, respectively. This rapid decline in yields led to a 0.7% appreciation in the Bloomberg U.S. Aggregate Bond index for the week. Economically sensitive cyclical stocks also outperformed less sensitive consumer staples by a significant margin.
As expected, the Fed left short-term interest rates unchanged at its meeting last week. Despite recent high inflation readings, the median Fed forecast for three interest rate cuts in 2023 remained the same. Forecasts for PCE inflation and economic growth were revised higher, while jobless rate estimates were reduced.
Powell addressed the higher inflation in February, attributing it to progress towards the Fed’s 2% inflation objective over time. He stated that the inflation trend is lower despite some bumps along the way. Powell also believed that higher wages were not the cause of elevated inflation, indicating that the labor market imbalances have mostly been resolved and wage growth is moderating.
Markets reacted positively to Powell’s rate cut-friendly comments, with an 85% chance now priced in for a Fed easing in June, up from 60% the prior week. The odds now favor a June or July start to the Federal Reserve’s short-term interest rate cuts, with markets expecting three cuts of 25 basis points each in 2024. The indication that the Federal Reserve would be more responsive to economic softness than elevated inflation boosted risk assets.
The increased expectation of a Fed easing has lowered the probability of recession, as markets now view the hurdle for the Fed to ease monetary conditions as lower than previously thought. However, there is still a risk in the markets if there are any disappointments. While Powell downplayed the risk of wage growth leading to services inflation, this remains an area to watch closely for potential issues. The holiday-shortened trading week is not expected to have any significant market-moving releases, but several Fed speakers are scheduled to provide further insight.
