Happy New Year! We had a nice drift higher into the end of the year for stocks. This, of course, was fueled by the Fed's acknowledgement in its December meeting that the next move in rates will be a cut.
And as we enter the New Year, the question is, how soon?
The Fed projected June at its most recent meeting. The market has been projecting the first cut to come in March. But we may see it as early as this month (the Jan 31 meeting).
Why? As we discussed last month, the sharp fall in the most recent inflation data (from 3.5% to 3.2% in the Fed's favored gauge, core PCE) now has the annualized average monthly change of the last six months below the Fed's target of 2%.
Remember, the Fed has told us through its Summary of Economic Projections that it believes the neutral rate (neither stimulative nor restrictive) to be about 0.5% above its inflation target. They are a long way from that mark, with the effective Fed Funds Rate at 5.3%.
And also remember, they have told us explicitly that they will have to start cutting rates well before inflation hits their 2% target, or they will risk inducing a deflationary spiral (which would induce an economic downward spiral and an increase to the already record debt burden) – a toxic outcome.
So, January 11th will be a big day. That's when we get the December inflation data (CPI).
With this in mind, the scars are still fresh from the Fed's 2021 mistake, where it was too slow to respond to the clear inflation threat.
This sell-off in stocks as we start the New Year might be reflecting bets that the Fed has, again, positioned itself behind the curve — this time on the deflation threat (vulnerable to making another mistake in 2024).
I suspect a weak CPI number on January 11 will prompt a reaction from the Fed (a January cut).
That (an early rate cut) sets up for a breakdown in the dollar, which we discussed in my last note of 2023. And a weaker dollar can help alleviate the accelerating disinflation threat (i.e. it can stabilize inflation).
Let's take another look at that chart …
And a lower dollar sets up for a resumption of the post-pandemic commodities bull cycle …
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