Although holiday trading has been slightly lackluster, the US stock market has not stopped its upward momentum. After the Federal Reserve's year-end decision, the market's expectations for interest rate cuts have become increasingly strong. With the weakening of US bond yields and a resurgence of risk appetite, the three major stock indexes have ushered in their best performing December in nearly a decade.
As we enter the new year, the game of policy shifts will continue, and the impact of the latest non farm payroll report to be released this week on the expectation of interest rate cuts will become the focus.
The Federal Reserve's policy will face a major turning point
After raising interest rates by 25 basis points in July last year, the Federal Reserve has held three consecutive meetings to maintain the federal funds rate unchanged, and the tightening cycle of 525 basis points is expected to come to an end in this round.
As the effects of monetary policy gradually emerge, the inflation rate in the United States has rapidly fallen from its nearly 40 year high in the middle of last year, and the overall CPI is approaching 3%. Consumer surveys by the Federal Reserve of New York and the University of Michigan also show that short-term inflation expectations are also falling. Although there is still some way to go before the mid-term target of 2%, the Federal Reserve sees hope in the anti inflation trend and mentioned interest rate cuts for the first time at its recent meeting.
The huge shock in US bond yields over the past year also reflects a reversal of policy expectations. The two-year US Treasury bond, which is sensitive to policy expectations, fell 15.1 basis points throughout the year, marking the first decline in nearly three years. The yield of benchmark 10-year treasury bond broke through a 16 year high of 5% at the beginning of the fourth quarter of last year. The rise in crude oil prices triggered speculation about long-term high interest rates. Later, concerns about demand destruction, rising inventories, warmer weather in the northern hemisphere and other factors eased the supply and demand relationship in the energy market, making the inflation rate fall more than expected. As of the close, the 10-year US Treasury bond fell to 3.80%, nearly 140 basis points from the year's high.
At the same time, although there has been a slight cooling compared to the third quarter of last year, the overall US economy continues to maintain resilience. The manufacturing industry remains sluggish, the real estate market is mixed, and the main part of the US economy - the service industry - remains in an expansion range, indicating stable demand during the year-end holiday season. The number of initial jobless claims is at a historical low of around 200000, and the labor market remains healthy, thereby strengthening the prospect of a soft landing.
Federal funds rate futures show that the market continues to bet on the prospect of the Federal Reserve cutting interest rates. The probability of lowering interest rates by 25 basis points in March is expected to remain above 70%, and the potential for a full year rate cut is expected to be above 150 basis points.
Institutions have significant differences in their views on policy paths. Goldman Sachs recently released a report stating that in the context of cooling inflation, the Federal Reserve expects to start lowering benchmark loan rates as early as March. The bank believes that the Federal Reserve will cut interest rates by 25 basis points for three consecutive times from March, and then cut interest rates quarterly until the interest rate reaches 3.25% to 3.50% in the third quarter of 2025. In contrast, UBS, Oxford Institute of Economics, and Santander Bank are expected to have only 2-3 rate cuts this year.
Can the New Year market go further
The trend of the US stock market in 2023 can be described as ups and downs. The wave of artificial intelligence in the first half of the year has driven the technology stock market, while concerns about the Fed's long-term high interest rates have caused nearly three months of adjustment. Starting from October last year, the expectation of the Fed's interest rate cut gradually strengthened, leading to a successful conclusion for the three major stock indexes. During the nine consecutive weekly gains, the Dow Jones Industrial Average has repeatedly hit new historical highs, while the S&P 500 index is less than 0.5% away from its 2022 high.
By industry, the information technology sector has become the biggest winner, rising 56.8%. Nvidia and Meta Platforms have risen more than threefold, making them the best performing companies in the S&P 500 index. The growth rate of sectors such as finance, raw materials, and industry has also reached double digits.
However, three sectors have also fallen against the trend. Public utility stocks fell more than 10%, while the rise in US bond yields suppressed the attractiveness of high dividends. The mandatory consumer goods sector has also been affected, with inflation factors suppressing the pricing power of many manufacturers. The energy sector plunged at the end of the year, and crude oil prices fluctuated and fell under the joint impact of the United States and non OPEC oil producing countries, falling nearly 20% in the fourth quarter of last year.
The flow of funds shows that investor sentiment remains optimistic, and US stock funds have attracted a large influx of funds. According to data from the London Stock Exchange (LSEG), US stock funds saw a net buy of $14.57 billion, a six-month high, boosted by expectations of interest rate cuts. Large cap and small cap funds attracted $8.93 billion and $3.63 billion respectively, reflecting the recent strength of related sectors.
Interest rate expectations continued to suppress the upward trend in US bond yields, helping small cap and financial stocks that are sensitive to interest rates to participate in the year-end rise. Optimism also stems from the hope that the Federal Reserve can guide the economy towards a "soft landing" and avoid an economic recession. Investors have shifted their focus to the December non farm employment report to be released on the 5th.
Jiaxin Wealth Management wrote in its market outlook that overall, the anti inflation trend will continue to have an impact on the market in the new year, not just in the manufacturing industry. Pricing power has driven the recent profit growth of many industry companies, but it is still unclear whether companies can still improve profits by raising prices.
The institution believes that any unexpected upward trend in the latest non-farm data may prompt investors to quickly reassess when the Federal Reserve may cut interest rates and expectations of easing space, thereby triggering market volatility. Although interest rate futures have shown the prospect of 5-6 rate cuts, many market views believe that such views are too optimistic because the Federal Reserve has not seriously discussed policy shifts.