With three rate cuts projected for 2024, the Fed is signalling it is prepared to run this economy hot. There is a distinct possibility that real rates have now fallen below neutral. With a widening federal budget deficit, this will juice the economy and stock returns, in the short run. The S&P 500 has a clear path to 5,000.
Since the payrolls report last Friday, the Atlanta Fed GDPNow estimate for Q4 has been revised up from 1.2% to 2.6% q/q annualised. Real PCE is tracking at 3.0% q/q annualised, adding 2.02 percentage points to growth. Government spending is projected to add another 0.61 percentage points to Q4 GDP.
This Fed pivot will be seen in some quarters as a deeply political move, to inflate the economy in the run up to the 2024 election. Whatever the merits of this argument, the Fed has signalled its intentions: the reality is that the Fed is going to be cutting rates into an economy that is strengthening. Nominal GDP looks set to keep growing at a rate north of 5%.
Ultimately, it is hard to see how this will be positive for long bonds. Fiscal policy is far too loose, and there is little control over spending. The tight labour market should embed services inflation, as the Fed eases. Term premia should rise, and Treasury curve should be positively sloped. The sweet spot for the equity market is now, and for the next few months possibly, with Treasury yields down sharply from the highs, and growth remaining strong. The Fed pivot is the main driver of pricing currently. But over time, the 10-year Treasury yield should begin to climb again, reaching 5% by the end of next year.
