· Market participants bet on a Fed Pivot, causing financial conditions to ease most on record

• Has the market got it right this time

Too much romance between the markets and the Fed has led to this flirting with a soft-landing narrative.

Markets are front-running the Fed’s actions, expecting policymakers to ease financial conditions by cutting rates 5 times next year.

That has caused the Goldman Sachs Financial Condition Index to drop the most in its 43-year history, which might be viewed as the future path for the Fed policymakers.

Source: ZH

However, one should not get too complacent that the market has it right this time.

Last year, a similar scenario took place, where Mr. Market expected rate cuts for 2023 that never happened.

This led to Bonds having a turbulent year and were on track to mark their 3 ^rd straight year of losses, until the November rally took place. In a stunning reversal, the 10Y Treasury Bonds nosedived 80 basis points on softer inflation data over the last few weeks.

Although the US Central Bank has not yet lowered its market rates yet, borrowing costs plunged, and rate-cut optimists skyrocketed stocks, causing the S&P 500 to climb 9% in November.

However, market participants seem to be selectively listening to only the FOMC dovish members.

Fed Chair Powell has kept his more hawkish stance, reiterating that it’s still early to declare a victory lap on the inflation fight.

This week’s US job openings dropped to a 2.5-year low in October, indicating that higher rates are cooling off demand for labour.

Next year, the economy will likely continue to slow down as the Fed makes sure it does not lower its key rates prematurely, leading to a re-surge in inflation similar to what happened in the 1980s.

The market dreams of significant rate cuts of nearly 125 basis points, with the first one likely occurring in March of 2024, implying that the cause for that will be a recession next year.

Source: ZH

Markets have their own reality, and it’s certainly plausible that they could be carried away expecting too many cuts too quickly in the same manner they over-reacted to the „higher for longer“ stance earlier this fall.

And again, there is no reason to believe that the market has it right this time.

The OPEC+ cartel recently agreed to cut output in 2024, war continues in Ukraine, and escalating geopolitical conflict in the Middle East will all keep the likelihood of future oil shocks elevated.

If oil prices reverse and labour markets continue to show strength, inflation could again surprise the upside, leading to a sharp re-reprisal of risky assets.

Finally, a lot of critical data will come in the two weeks leading up to the Christmas holidays, including inflation prints and the FOMC meeting on December 13^th. This will shed more light on the Fed’s future policy path and whether the market agrees or continues to disagree with it.

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