Rate Hike Unlikely: Expect S&P 500 To Rally To New All-Time Highs (SP500)

Thesis In A Nutshell

The S&P 500 (SP500) has tumbled over the past few weeks, as hotter-than-expected inflation readings pushed up speculation for a potential rate hike in 2024. However, the FOMC meeting for April/May gave investors some relief, as Fed Chair Jerome Powell indicated that a rate hike is unlikely to be the committee’s next move. This, in my opinion, underscores speculation that the Fed maintains an easing bias in 2024; and on the backdrop of this assumption, I expect that equities are poised to rally towards new all-time highs soon.

Higher For Longer, But With Easing Bias

In the April/May FOMC meeting, the committee maintained funding costs for fed funds in the range of 525-550, and projected that rates will likely stay higher for longer, pointing to a lack of progress in the fight to bring Inflation down towards 2%.

In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective […] The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent

For context, in March, the personal consumption expenditures index, the central bank’s preferred measure, increased by 2.7% from the same month last year. This marked an acceleration from January’s 2.5% increase.

However, investors should note that the Fed has come a long way in bringing the pace of inflation down over the past few quarters, and the current macro backdrop supports speculation that the Fed is willing to ease financial conditions, as “employment and inflation goals have moved towards a better balance.”

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals have moved toward better balance over the past year. The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks.

In the conference following the FOMC press statement, Fed Chair Powell added confidence in the suggestion that the committee is overall willing to cut rates. Powell said that it is “unlikely” that the next move of the Fed will be a hike, adding that the major focus point of discussion for committee members revolves around the question for “how long” rates will remain restrictive. So, in my opinion, the speculation regarding the Fed’s next steps focuses more on timing rather than direction. And I see the first cut in 2024 as highly likely. That said, even if rates stay higher for longer, investors should not ignore the fact that the Fed may have already started to ease financial conditions–pointing to the committee’s recent decision to notably slow the pace of securities sales and balance sheet contraction.

Beginning in June, the Committee will slow the pace of decline of its securities holdings by reducing the monthly redemption cap on Treasury securities from $60 billion to $25 billion.

Traders Agree With The Easing Bias

Pointing to the CME Fed Watch Tracker, following the most recent FOMC meeting, I highlight that markets broadly agree with my view that rates are poised to be cut in 2024. In fact, less than 20% of traders currently expect that the Fed funds rate remains at the current 525-550 range. Interestingly, virtually no notable position is recorded for a speculation that projects rates to end 2024 higher (plus one rate hike). At the same time, around 40% see one rate cut as probable, while approximately half of market participants expect more than one cut.

Looking at a more longer-term expectation picture, I highlight that rates projections are normally distributed at around 425-450, which would suggest a 100 basis point drop in rates over the next 15 months. So again, markets are definitely reading an easing bias in the Fed’s commentary.

Q1 Earnings: Better Than Expected

Looking beyond rates, it is notable to point out that companies are reporting strong commercial momentum. According to data collected by FactSet, in the first quarter of 2024 reporting period so far, with 46% of S&P 500 companies having reported, 77% have exceeded earnings per share expectations, and 60% have surpassed revenue forecasts. This trend of better-than-expected earnings has been noted across all major S&P 500 sectors. Needless to say, this supports a strong bullish thesis for equities.

Investor Takeaway

Over the past few weeks, the S&P 500 has suffered a contraction, as unexpectedly high inflation readings fueled speculation about a potential rate hike in 2024. Against this fear, the FOMC April/May meeting offered some reassurance to investors when Fed Chair Jerome Powell indicated that a rate hike is unlikely to be the committee’s next step. In fact, the committee kept speculation alive that one or more rate cuts in 2024 might be possible, while the Fed notably reduced the pace of balance sheet contraction. Overall, this suggests to me that the Fed might continue with an easing stance throughout 2024. Based on this assumption, I anticipate that equities are positioned to soon rally towards new all-time highs, especially as earnings for Q1 come in better than expected.