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Can the Santa Rally survive a more cautious Fed?
Investors must recalibrate to a slower pace of rate cuts and higher inflation.
Welcome to a shortened trading week. While all three stock indexes finished last week lower, Friday brought movement to what may be the start of the Santa Rally investors have been seeking.
Programming note: Trading ends early on Tuesday and markets remain closed for Christmas, so look for the next edition of Opening Bell Daily in your inbox Thursday.
Today’s letter is brought to you by Public!
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Recalibrating expectations
For all the buzz around artificial intelligence and the Trump Trade, the Federal Reserve continues to dominate the narrative in financial markets.
Through most of 2024, that’s been a boon for asset prices.
The S&P 500 has soared 25% year-to-date, valuations have ballooned to 2022-levels and bitcoin continues to flirt with six-figures. Institutional and retail investors alike have piled in, emboldened by the belief that the Fed would lower borrowing costs sooner than later.
Policymakers shot down that assumption last week.
While the Fed has slashed its benchmark interest rate by 100 basis points since September, the December meeting revealed upward revisions to the outlook for interest rates and inflation.
“When the risk-free rate goes up, it raises the bar for returns on equities, particularly in a situation where returns in equities have been driven entirely by a handful of tech stocks,” said Apollo chief economist Torsten Slok.
Credit: Apollo
Markets recalibrated and sold off on the news that cheaper capital may not arrive so quickly, underscoring the fragility of a rally built on policy optimism.
The big disconnect
Fed Chair Jerome Powell described the December rate cut as a “close call.”
At the same time, Wall Street had assigned a 95% probability for the move, highlighting the disconnect between both counterparts.
Two questions come to mind:
Is the Fed making decisions based on market expectations or economic data?
Are investors so fixated on cheap capital that they are ignoring economic data?
Because Powell’s latest messaging is at odds with recent hot inflation prints, these questions are sure to shape how markets move in 2025.
The cutting cycle so far has been guided more by sentiment than economic data. Powell & Co. have gone to great lengths to avoid surprising markets, but in doing so, they may have created a feedback loop that leaves investors vulnerable to a pullback if inflation and rates remain elevated.
The Fed appears to be gaining control once again, yet a handful of tailwinds could end up putting markets back in charge.
“A mixture of resilient US activity, lower borrowing costs, a broadening of US earnings growth, further AI monetization, and the potential for greater capital market activity under a second Trump administration create a favorable backdrop for US equities,” said Solita Marcelli, UBS Global Wealth Management’s chief investment officer for the Americas.
In any case, the gap between speculative hopes and monetary policy will shape how far asset prices can climb in 2025.
The more immediate question is whether anything beyond a Santa Rally can withstand the weight of a more cautious Fed.
Comments or feedback? Reply directly to this email or let me know on X @philrosenn.
Elsewhere:
👀 Warren Buffett bought more stocks. During last week’s market sell-off, Berkshire Hathaway scooped up 8.9 million shares of Occidental Petroleum, bringing its stake to 28% in the energy firm. In the same couple days, Berkshire also bought 5 million shares of Sirius XM and 234,000 shares of VeriSign. (CNBC)
🚀 Business is booming for Wall Street once again. Dealmaking and trading are up, interest rates are lower than a year ago, and bankers are salivating at the prospect of looser regulations under Trump 2.0. Shares of Goldman Sachs, JPMorgan, Citi, and others have all rallied since the election. (Yahoo Finance)
Traders see 92% odds the Fed keeps rates unchanged in January, according to Kalshi, the biggest US prediction market:
Rapid-fire:
November PCE, the Fed’s preferred inflation gauge, came in lower than expected Friday at 2.4% (Official release)
China’s property crisis is entering its fifth year and there’s little sign that real estate developers can dig themselves out of debt (Bloomberg)
Stock market apps and options trading has led more and more men to join Gamblers Anonymous meetings (WSJ)
President-elect Trump has asked Panama to lower its “rip-off” transit fees or return the canal to the US (Bloomberg)
Palantir and Anduril are joining forces with tech groups to bid for Pentagon contracts (FT)
Homebuilders are seeing profit margins shrink, which could lead to affordability adjustments and therefore more homebuyers in 2025 (ResiClub)
Last thing:
Trump announced that @SteveMiran will serve as the CEA chair, pending Senate confirmation, in his administration.
Miran has been highly critical of the Yellen Treasury’s debt management policies and the Powell Fed’s monetary policy
— Nick Timiraos (@NickTimiraos)
3:58 PM • Dec 22, 2024
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