By Michael O’Neill
“It’s elementary, my dear Watson, interest rates are going lower.” That’s what Sherlock Holmes would say if he studied the dot-plot graph in the Summary of Economic Projections (SEP) from the December 13 FOMC meeting. They point to 75 bps in rate cuts by the end of 2024.
The FOMC statement tells a different story. The tone is hawkish. That’s because the FOMC said it is leaving rates unchanged in order to manage elevated inflation levels, with a dollop of caution about tightening rates if warranted.
The doves were given a nod with the acknowledgment that economic activity slowed compared to the November statement which described economic activity as “expanding at a strong pace.”
To paraphrase Mr. Holmes, “You hear but you do not observe.”
The market completely dismissed the slightly hawkish tone of the statement and focused on the SEP forecasts.
Fed officials see the US economy growing a tick faster in 2024 (new forecast 1.5% vs. previous 1.4%), the unemployment rate remaining unchanged at 4.1%, and Core PCE falling to 2.4% from 2.6%. More importantly, officials downgraded the Fed funds projection to 4.6% from September’s 5.1% guess.
The result was predictable. The US 10-year Treasury yield plunged 14 bps to 4.01%, from 4.16% ahead of the SEP. The S&P 500 index surged 1.37% and gold prices jumped $47.00. The US dollar went into freefall, with the US dollar index dropping 1.0%.
So now what?
It is hard to believe that the US dollar will continue to sink dramatically in light of elevated global tensions. The US Congress is balking at funding two wars (Ukraine and Gaza), and China may see that reticence as an opening to annex Taiwan. China is a destabilizing force. It only pretends to be a good global citizen while using its military to enforce its bogus claim that the entire South China Seas belongs to them. Beijing blatantly ignores United Nations Court rulings that, except for 12 miles from China’s coastline, the South China Sea is international waters. Beijing is also cozying up to every enemy of the US, including Iran, the regime responsible for the terrorist strife in the Middle East. Those risks make the greenback a rather attractive haven.
If the USA bails on supporting Ukraine, Vladimir Putin will crush the opposition and the Russian flag will flutter over the Verkhovna Rada building. How long before European politicians beat a path to the door of the Kremlin seeking new oil and gas deals while praying Vlad’s territorial ambitions stop at the Ukraine border? It isn’t a stretch to assume that investors would prefer US dollars to Euros, Kroner, or even Swiss francs.
It’s year-end. The S&P 500 has had a banner year, especially if the year started in the first week of November. However, it is looking overdone on technical studies. A Goldman Sachs analyst said that the gains since October 27 are largely because Commodity Trading Advisors put on $106 billion of long equity trades and they may be motivated to book profits before Christmas. Diving US equity markets usually mean demand for US dollars.
The dot-plot clues not only provide US interest rate guidance but also direction for the Canadian dollar. That’s simply because the US dollar is the tail that wags the dog, and the reality is the Loonie is merely a flea on that canine.
It was no surprise the Bank of Canada left interest rates unchanged on December 6. The result was a given due to expectations that the Fed would leave rates unchanged at the December 13 meeting (they did). Just like the December 13 FOMC, the BoC statement warned that policymakers are “still concerned about risks to the outlook for inflation and remain prepared to raise the policy rate further if needed.” In both cases, analysts laughed.
Furthermore, cynics said that there was no way BoC officials would want to incur the wrath of the public and government by being the only major central bank to raise rates. (The Bank of Japan doesn’t count). The Bank of England and the European Central Bank monetary policy decisions are on December 14, and traders have already priced in a series of rate cuts in 2024.
The dot-plot suggests at least three US rate cuts in 2024. The Bank of Canada will likely match each one. If so, the CAD/US 10-year yield spread will stay close to its historical low and undercut attempts to rally the Loonie. USDCAD may be on the defensive but until it drops below 1.3200 for a a sustained period, the thirty-month uptrend remains intact.
The dot-plot may show the game is afoot, but as Mr Homes says, without “data, data, data, you can’t make bricks without clay.”
