Connecting the Dots

Fed dot-plot December 2023.

An eventful week in the markets as the Fed announcement on Wednesday provided an unexpected surprise with regard to their expected forward path of interest rates.

If you don’t know, the Fed releases a dot-plot graph in their policy statements which shows each Governor’s expected forward path of interest rates (see adjacent graphic). These charts are closely watched for changes in policy as Fed officials do not say publicly what they think in private. In essence, this chart allows Fed officials to indirectly communicate to the public their own individual thoughts on the direction of interest rates.

This week was a big change from the September dot-plot where there were projections for one more 25bps rate increase. In fact, there are no further rate hikes expected and several members now expect 75-100bps in rate cuts in 2024. The rationale could be based in lower inflation or a weakening economy or it may mean that the distortion fields from the COVID shutdowns are now beginning to fade and a less hawkish policy is required.

The S&P 500

The stock market loved the inflation data from earlier this week and the dot-plot was the cherry on top. The DOW made new all-time highs and the S&P is now headed in the same direction. You can see the S&P’s price action on the right side of the chart and the momentum indicators at the bottom show there could be more upside into 2024.

The S&P 500 by @kiscocap.

10-Year Treasury Yields

The chart below shows the 10Yr Treasury yield as a 5-wave impulse pattern and that means we should see rates continue higher in the coming years. In the meantime, the 10Yr is falling and is likely to retrace back to 3.23% and maybe a bit lower. This would certainly be good for the residential and commercial real estate markets and provide a positive development for high yield bonds and equities.

The 10Yr Treasury yield by @kiscocap.

The Shape of the Yield Curve

An inverted yield curve has been a very good predictor in the post WWII era for recessions – typically within 24 months. The only exception was in 1966 but the DOW made a 13-year high so it did signal weaker times on the horizon. Will today’s environment be an exception to this relationship? There is an argument to be made that shutting down supply chains in 2020 had distortion effects that are still reverberating around global economies as the boom/bust cycle among the various sub-sectors of the economy are apparent. There is bad news out there but not all at once and in the same place which is typical of most recessionary environments where the economy falls off a cliff.

The yield curve by @kiscocap.

This makes the job of the Fed very tricky as their tools are blunt and work with lags. So, the question will be how the curve flips from inverted to positively sloped. As you can see in the chart earlier of 10Yr yields, we should expect long bonds to rise in yield and if the Fed cuts next year then we should have a normalized yield curve in the latter half of 2024. So, this rate cycle looks to have concluded and now we are on to watching earnings reports, job creation and inflation (or deflation) for signs of an upcoming recession. So far, we are not seeing it.

Paul McCarthy of Kisco Capital, LLC

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Paul J McCarthy III

President, Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.