The Fed could struggle to stick to their dovish rhetoric

Federal Reserve preview

There are also two major central bank meetings and a raft of economic data that is worth watching. The Fed will announce interest rates on Wednesday. No change is expected, and there will be a press conference afterwards, so the focus will be on the accompanying statement and what Jerome Powell is willing to tell the press. Analysts will be watching to see if the Fed suggests that the market is getting too excited about the prospect of multiple rate cuts this year. The market is pricing in just over 6 rate cuts for 2024, with the first rate cut now expected to come in May, and for rates to end the year at 3.95%. The Fed’s last ‘dot plot’ only had 3 rate cuts expected by the FOMC, who actually make the rate decisions.

Why stocks could stymie Fed rate cuts

The recent stock market acceleration in the US could be a fly in the ointment for Fed rate cuts. The rally in US stocks added $8 trillion to share holder value, the S&P 500 set fresh records in 5 straight sessions in the last week, and financial conditions are at their loosest since 2022, as you can see in the chart below. This is one of the many metrics that feed into the FOMC models that help the Fed to make rate decisions. This input is flashing a warning sign about cutting rates too quickly.

Chart: Goldman Sachs US financial conditions index 

Source: Bloomberg 

The Fed could struggle to stick to their dovish rhetoric

A market rally on the assumption of rate cuts, rather than rate cuts themselves could be counter-productive since this is a form of easing, and it may make the Fed less willing to cut rates. For the Fed’s meeting this week, this means that the Fed could struggle to lean into their recent dovish rhetoric. In its simplest terms, the recent stock market rally gives the Fed a reason to delay rate cuts, but if the bull run in stocks comes to an end, then rate hikes could become more likely. Looking forward, the Fed may go from having an inflation problem, to having an asset price problem, which may prove to be just as tricky to disinflate. The market may find out this week that it can’t have it both ways.

Overall, there is a risk that US stock indices could come under pressure on the back of this FOMC meeting, especially if the dovish tone from the December Fed meeting is shelved. As mentioned, if the Fed continues to push back on recent dovish rhetoric and say that they remain data dependent, then the market may struggle to digest this. The lack of clear communicaiton could be filled with market panic and speculation if the Fed pushes back too hard on rate cut expectations. The dollar was mixed last week, and started to make gains vs, the EUR, GBP and JPY. If the Fed is considered less dovish than it was in December, then we could see a broad-based dollar rally and a selloff in risky assets.

BOE faces different set of challenges from the Fed

The Bank of England also meet this week, and we will send out a preview ahead of time. However, we expect a dovish shift from the BOE and even though UK stocks outperformed US stocks last week, there has been no bull market for the FTSE. The FTSE 100 is lower by more than 1.2% so far this year, and by 1.4% in the last 12 months. The BOE does not have to worry about a stock market bull run stoking inflation pressures in the UK.