Brian Pietrangelo:
Welcome to the Key Wealth Matters weekly podcast where we casually ramble on about important topics, including the markets, the economy, human ingenuity, and almost anything under the sun, giving you the keys to unlock the mysteries of the markets and investing. Today is Friday, December 15th, 2023. I'm Brian Pietrangelo and welcome to the podcast.
Today, we have a special programming note in that this is our final podcast for 2023. We'll be taking a break for a few weeks to celebrate the holidays with our family and friends. So on behalf of all of my colleagues at KeyBank, we would like to wish you a happy holiday for all religions, certainly a Merry Christmas, and also, peace on earth as we go into the new year. Happy holidays, everybody.
With me today, I would like to introduce our panel of investing experts, here to share their insights on this week's market activity and more. George Mateyo, chief investment officer, Rajeev Sharma, head of Fixed Income, and Cindy Honcharenko, director of Fixed Income Portfolio Management. As a reminder, a lot of great content is available on key.com/wealthinsight, including updates from our Wealth Institute on many different subjects, and especially our Key Questions article series addressing a relevant topic for investors each Wednesday. In addition, we have posted our 2024 economic and investment outlook on key.com as of December 11th. So if you're looking to see what our thoughts are for the upcoming year, you can certainly find it there. Finally, as we say every week, if you have any questions or need more information, please reach out to your financial advisor.
Taking a look at this week's market and economic news, we've got a few reports to share with you. We'll begin with a measure of inflation known as the Consumer Price Index, which showed some modest slowing month over month from last year. In October it was 3.2%. It modestly declined at 3.1% in November. However, if we look at the core CPI, which excludes the volatile food and energy subcomponents, it was flat. Meaning last month it was 4%, this month it was 4% as well. So there's still some stubbornness in some of the underlying subcomponents of inflation, which led to a favorable outlook on the report, however, not as strong as some people would've preferred. Secondly, the initial unemployment claims report for the week ending December 9th showed a decline, down to 202,000 for the initial claims. So that again shows resiliency in the job market, which is good news going forward into 2024.
Yesterday, we received the advance monthly sales report, otherwise known as retail sales, for the month of November that showed a positive 0.3% increase month over month from October, which was a little bit of an upside surprise in that folks had thought that the overall retail sales numbers would begin to decline based on some of the underlying measurements that we had been seeing over the past few months. But this month it actually showed some more resiliency in terms of the overall retail sales from the consumer spending perspective. Just this morning, some favorable numbers on the overall industrial production across the United States, which was up for the month of November on the preliminary read, 0.2%. That's positive because October was down almost 0.9% in terms of overall industrial production. So seeing some good signs there in terms of manufacturing across the nation.
Now we get to the big news of the week, which was on Wednesday with the press release from the Federal Open Market Committee meeting where Jay Powell and the committee talked about their future outlook for 2024. In addition, they held rates constant for the meeting at 5.5% for the Fed funds rate, but everyone cheered, basically, the following day and that afternoon in terms of a market rally based on the expectation that the Fed will begin easing a little bit more than had been predicted in the past in terms of their 2024 outlook. We'll get our experts take on that in terms of what's happening in the overall Fed speak.
With that, let's turn to Cindy right away to get that update first here on our podcast. So Cindy, what did the Fed do? What did the Fed say? And what was their outlook for 2024? Cindy?

Cynthia Honcharenko:
The Federal Open Market Committee left the target range for the federal funds rate unchanged at 5.25% to 5.50%. This was a unanimous decision in line with market expectations and the third consecutive pause. The overall tone of communication from the FOMC meeting showed participants are increasingly confident that they have achieved a sufficiently restrictive policy stance. The committee paid lip service to the prospect of further tightening, and they reserve the right to do so. But it is evident that they're starting to pivot their focus on the timing of rate cuts. The summary of economic projection shows a better 2023 inflation outcome and more cuts in 2024. The latest projections for stronger economic growth and low unemployment with a significant downgrade to the inflation profile increasingly reflected the committee's expectations for a soft landing. This theme was prominently featured throughout Powell's press conference.
The GDP growth forecast for this year was marked up 2.6% versus 2.1% at the September summary of economic projections, which is consistent with the Atlanta Fed tracking estimate for fourth quarter. That follows the economy's stellar performance in third quarter. Next year's GDP projections only saw a minor downgrade. The Fed still sees growth slowing below potential next year. Notably, projections for the jobless rate in the next three years did not exceed the Fed's estimate of the longer-run unemployment rate of 4.1. Also, reinforcing that soft landing theme. Both headline and core PCE inflation projections were revised sharply down for this year, 2.8 and 3.3%. They were 3.2 and 3.7% respectively for September.
Next year's forecast also reflected lower inflation 2.4% versus 2.5%. They were 2.4% and 2.6% respectively in September. The dot plot signaled 75 basis points of rate cuts in 2024 and a hundred basis points in 2025. But Powell emphasized that this is purely an amalgamation of the participants' forecasts and not a plan. Two participants saw no rate cuts, while the most aggressive forecast anticipated six. Powell repeated caution against premature declarations of victory in the Fed's inflation fight, but provided only limited push on the substantial inter-meeting easing financial conditions. He merely stated, "It is important for financial conditions to become aligned with what we want to accomplish. In the meantime, there could be back and forth. Ultimately they will have to come along."
So the markets broadly saw the Fed communication as dovish and pushed the probability of rate cuts at the January meeting to 17%, prior to the meeting that was 2%, and pulled forward the March probability from 42% to 90%. We still have much uncertainty ahead and plenty of economic data in the pipeline. Although this looks like a Goldilocks economy, investors need to remain cautious, stay diversified, emphasize quality, and increase duration modestly. George, Rajeev, I'm curious to hear your thoughts on the FOMC meeting this week.

George Mateyo:
Well, I think it was more what they think they might do versus what they did that kind of got the markets all excited, frankly. I think it was interesting to see that the Fed is thinking about cutting rates as much as they might do next year. I think we've been talking about this for a while now, that there's probably still a lot of momentum in the economy. Now, with conditions easing quite a bit, that's going to probably lead to probably more inflation at some point down the road. We're not there yet. As you mentioned, Cindy, we're kind of in this Goldilocks kind of environment where it's not too hot, not too cold. That seems to feel pretty good for most participants, ourselves included. But I think we have to kind of be mindful that we might go a little bit too fast, too quick in terms of how things play out from here.
That being said, I think it is kind of notable that in terms of why rates go down, I think that's going to matter more than the what. In other words, why rates are being lowered is important here. In other words, if rates fall down a lot or have to be lowered quickly because of economic weakness, that's one side of the story. Conversely, if rates are being lowered because the Fed thinks they've done ... done enough, rather, and are just taking back some of their over-tightening, if you will, then that's not a bad thing. That kind of sets us up for a pretty good backdrop overall. So we still think that this kind of soft landing makes a lot of sense. That's kind of our base case for the year ahead. But I think the outcomes are still pretty wide, that we have to be respectable about good things happening and maybe some bad things happening too. That's my quick takeaway. Rajeev, what do you think?

Rajeev Sharma:
Well, George, yes, it's been quite the week for fixed income, and specifically for the rates market following that FOMC meeting. The key here is that the market was expecting the pause in rates, but they thought the Fed would kind of come up there and reiterate that we need to be higher for longer. Instead, as Cindy said, we saw a Fed that was moving towards market expectations of rate cuts for 2024, and a Fed that sounded dovish. The market took this as rate hikes are done and rate cuts will begin next year. Before the week's FOMC meeting, the Fed had projected two rate cuts for 2024. The new summary of economic projections point to three rate cuts. The market expectations have now moved from four rate cuts to five rate cuts next year. So, essentially, the Fed moved towards the market, and then the market moved further away from the Fed.
This will continue to lead to rates volatility for next year and continue data dependency for both the Fed and the market. But we did see the immediate reaction on the yield curve. We saw the front-end yields being the most sensitive to Fed policy. They moved lower, significantly lower. Right on the news, right after the press conference was done, we saw the two-year Treasury note yield move 30 basis points lower. 30 basis points lower to 4.43%. The tenure moved 18 basis points lower to 4%. Now, last time we saw these kind of big moves lower on the yield curve was during the banking crisis back in March. Other than that, you'd have to go all the way back to 2008 to see these kind of big moves on the day.
Now, since the front-end move was outpacing the tenure, this is the kind of steepening of the curve that the market likes to see. It's good news for risk assets because it validates that the Fed is done. It validates that the Fed is done raising rates. It also makes these financial conditions easier for households and businesses. But you see that tenure US Treasury yield, it continues to slide. Now we're below 4%. Now we have to start thinking about resistance points. How much lower can the tenure go? The next resistance point for the tenure would be the 3.44% level, on the low side. And if we were to start seeing the Fed narrative change and the Fed try to reel back the market, the next resistance point on the high side is 4.35%. Again, the data will be very important to keep looking at to find these support points.
But we also had other news this week as well. We had the ECB, they came out. They held rates unchanged. They cut their inflation forecast as well. They kind of followed the cue of the Fed, but they specifically said that we have had no rate cut discussions. The market is not really listening to that. The market continues to price rate cuts for 2024. All of this is very good news for risk assets as we go into the new year. In particular, credit spreads have moved tighter on the week. Investment grade spreads six basis points tighter on the week. High yield spreads were 30 basis points tighter on the week. If we look at the five-year high yield CDS, that's also narrowed significantly on the week. This is all showing a lot of stability in credit markets. We're seeing a lot of excitement about credit markets.
One last thing I'd like to highlight is that the biggest trade of the year for 2023 was to put money into money market funds. We saw assets in money market funds head towards that $6 trillion point, but now you have a six-month yield falling from 5.6% to 5.33%. We could start to see money flow out of those money market funds and start flowing into stocks and bond investments.

George Mateyo:
Yeah, I'm glad you mentioned that Rajeev. That's been kind of a conversation I think we've had on these podcasts and other places, too, where we've kind of I guess suggested that people might want to consider extending duration a bit. Cindy talked about that too. It's not just looking inside your fixed income portfolio, but potentially, if you have excess cash, this is not to say that cash does not have a role in a portfolio, and there's a role for it in your overall balance sheet, but to the extent that you can actually extend duration a little bit, maybe take and deploy some of that excess cash into short-term fixed income. Obviously it comes with a bit more credit risk and some other things, too, but you could probably be paid pretty handsomely for that. So I think there's probably still some value in that trade even though rates, as you talked about, have come down quite a bit in the last few days or so.
The other thing, Rajeev, I think I'd be kind of curious to get your thoughts on is the notion that we've kind of talked about, the fact that this is either ... this could be a repeat of '74 or '94. Again, to put that in context, in 1974, the Fed essentially cut rates all too soon, only to raise rates later to try and get inflation back under control. So there was a bit of a respite. They actually then kind of adjusted policy pretty quickly and had to raise rates quite significantly because inflation came back. Actually, I don't think inflation actually went down that much in the '70s, in the early '70s, rather, it was just some weakening of the labor market that caused the Fed to pivot.
Now, you contrast that with what happened in '94, the Fed raised rates a lot, and then they paused essentially. All went pretty well from that perspective. I guess I kind of put that in context. We did have an inflation reading this week, which was a little bit hotter than expected. Not worsen, but the market kind of discounted it, kind of shrugged their shoulders and said, "Well, let's focus on the Fed and what they might be doing with respect to rates." So are we past the concern about inflation in your view?

Rajeev Sharma:
I think it's very hard to get past the concern about inflation because the Fed continues to have that 2% point of inflation that they want to see. They've set that as their target ... the target level of 2%. According to their forecast, they're not going to get there until 2026. So I think that keeps the Fed in play. They want to stay in play. I don't think the Fed likes these looser financial conditions. I think the Fed's going to not want to make a policy mistake like they did back in the day.
The policy error is the one thing the Fed doesn't want to do, which could cause a lot of ... If they cut prematurely, start cutting rates and have to all of a sudden see inflation is not headed towards their target and they have to start raising rates, that's just going to lead to a lot of financial problems for the markets. I don't think the Fed wants to do that. So I see a Fed that's going to try to thread the needle and err on the side of caution and really look at the data. They need to continue to see inflation trending downwards before coming up with a rate cut. But just the notion that there's a Fed pivot is enough for ... and that's what we got this week, that's enough for the markets to really run with it.

Brian Pietrangelo:
One last piece, Rajeev, for you. We don't have a dynamic that we haven't had in a long time, but when we get into 2024, we're going to be having the prospect of rate decreases and rate cuts at the same time as quantitative tightening still occurring. So that'll be something that the Fed and the markets have to consider. You have any thoughts on that?

Rajeev Sharma:
That is a very interesting point, Brian, because that's something we haven't seen before. I think the markets are not really thinking about the tightening aspect of it right now. They're fully focused on rate cuts. We could see more volatility in the market. If the Fed starts to talk about the quantitative tightening piece, I think you could start seeing a market that's saying, "Wait, maybe rates need to stay higher for longer," but I think that that's going to be a dynamic that's going to play out next year.
One other thing I would add is we've been seeing mortgage rates going down quite a bit as well this week. That's another area that I think the Fed's looking at to see, "Is it sustainable to be below 7% or do we need to change the narrative?" Fed's going to have a lot of opportunity and Fed members have a lot of opportunity to change the narrative and start maybe focusing on the quantitative tightening piece to kind of get the market to focus on it. Maybe we could see some more volatility in the rates market because of that.

Brian Pietrangelo:
Thanks, Rajeev. George, we recently posted our 2024 investment and economic outlook to key.com For those readers that would like to take a look. Do you want to summarize a couple of thoughts that you have as we come into our year end here in terms of looking into 2024?

George Mateyo:
Sure, Brian. I think to some extent it's already kind of come true, so it might be a little bit premature to talk about 2024 in the sense that what happened in the last few weeks or so has been kind of previewed, I guess, a bit in our outlook. Again, what we talked about was this no landing, soft landing scenario coming to fruition a bit. That still seems to be the case.
I do think it's kind of notable to suggest that things are setting up for a pretty good, I guess, setup in the next few weeks or so. But I guess if Steve were here, he'd probably point to the fact that the overall technical side of the market is pretty healthy in the sense that roughly 70% of the stocks that are in the US equity market right now are above their 20-day movement average. I'm not a technician, but I think he would say that's a pretty bullish sign. In fact, somebody pointed out to me earlier today that that's only happened seven times in the last 40 years. And then the prospective returns going forward are also pretty juicy in the sense that when you have that much breadth and participation in the market, actually, it sets it up for gains going forward one year hence.
So I think our outlook, again, is kind of a bit more neutered towards that. You were right to point out that coming into this year, there were probably some predictions that a recession was at our doorstep. A year ago this time, there was one forecaster out there that said, "With 100% certainty, we're going to have a recession." Of course, that didn't happen. This year, right now, there's probably a consensus view that the soft landing that we've talked about for quite some time now is also going to play out with a lot of conviction. So I think we have to be respectful of the overall consensus and how that shapes out the outlook going forward.
But our view, again, essentially is more staying neutral right now towards risk assets in general. It's been a good backdrop, but stocks and bonds have both risen almost in concert with each other. So we still think that there's a good bit of opportunity beyond the Magnificent 7, further down the cap spectrum in equities, staying focused on quality, and also utilizing new tools where appropriate in a portfolio. So I think there's probably going to be more volatility than what we're seeing right now in the market.
The overall volatility in the equity market is kind of hovering around 10, on a scale of ... Well, it doesn't have a scale necessarily, but it's pretty low if you look at that 10 reading compared to history. I would suspect that we'll probably get through the holidays. Things will slow down in the next week or two. But then I think we have to be mindful of some probably resurgence of volatility in the [inaudible 00:19:36] part of next year. This is not a bearish call, but I think we want to be mindful that there's probably some opportunities, and also some risks that are still on the horizon too.

Brian Pietrangelo:
Well, thanks for the conversation today. George, Rajeev, and Cindy, we appreciate your insights. And thanks to our listeners for joining us today. Be sure to subscribe to the Key Wealth Matters podcast through your favorite podcast app. As always, past performance is no guarantee of future results, and we know your financial situation is personal to you. So reach out to your relationship manager, portfolio strategist, or financial advisor for more information. We'll catch up with you in the new year to see how the world and the markets have changed and provide those keys to help you achieve your financial success. Happy holidays, everybody.

Speaker 5:
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