Weekly Newsletter December 16th to December 20th
RECAPPING LAST WEEK
U.S. equities sold off sharply, and Treasury yields jumped after the Federal Reserve lowered interest rates but pared back expectations for future cuts. The S&P500 and Nasdaq Composite indices recovered some of the losses to finish lower by less than 2%, while the Russell 2000 tumbled more than 4%. Every S&P500 sector lost ground with sectors tied to real assets faring the worst. Crude oil prices slid 2.2% under pressure from a surging U.S. dollar and concerns over the demand outlook. Gold futures rose Friday but still lost 1% on the week. The 10-year Treasury yield reached a seven month high of 4.59% before easing slightly after the Fed delivered a “hawkish cut”. The committee’s intentions point to only two rate cuts in 2025, half of what was expected just three months ago (more details below). Fed Chair Powell expressed concerns about inflation picking up in his post-meeting press conference. November’s core PCE index revealed little movement in prices, but readings still held higher than the Fed’s target on an annualized basis. Headline inflation sat at +2.4% YoY, while the core measure was at +2.8% YoY. In other economic news, initial unemployment claims fell to 220k in the week ended December 14, reversing a spike from the week prior. U.S. retail sales increased at a steady pace last month, rising 0.7% as the holiday shopping season showed promise. The final estimate of Q3 GDP was revised up to 3.1% from 2.8%, partly due to stronger consumer spending. Manufacturing activity slipped in December on worries of higher tariffs raising raw materials pricing, while economic optimism sent the services sector flash PMI reading to its highest level in two years. U.S. housing data was mixed, as new construction rose last month in hurricane-affected areas of the south but fell in all other regions. Existing home sales surged to an eight-month high, but high mortgage rates and home prices weighed on the outlook for 2025. Overseas, China’s economy showed some signs of sustained recovery with industrial production rising 5.4% YoY in November. Retail sales however, missed the mark with just 3% growth versus estimates of 5%. The Bank of Japan kept interest rates unchanged at 0.25%,wiping out nearly all the yen’s rally from July through September. Governor Ueda said the bank preferred to wait for further evidence of rising wages, leading some economists to speculate that interest rate hikes may not happen until March at the earliest. Japan’s rising CPI supported action on rates, reaching +2.9% YoY. The Bank of England opted for no change in policy after UK inflation rose to an eight-month high, although surprisingly, three of the nine committee members voted to lower rates. Finally, Brazil’s central bank took extraordinary measures to stem a currency collapse as fears mounted over the country’s soaring budget deficits. Brazil’s stock indices have plummeted more than 15% in just over a week’s time.
THE WEEK AHEAD
This will be the last edition of this newsletter for this year with the next issue arriving on January 6. U.S. equity indices have seen very strong returns for a second consecutive year, led once again by the Nasdaq Composite at +30% through last week, followed by the S&P500 at +24%. With just five and a half trading days left in the year, there may be some residual volatility from last week’s FOMC decision, but investors probably prefer to coast into 2025. Congress was also scrambling to avert a government shutdown late last week. Most global markets will be closed this Wednesday for the Christmas holiday, and U.S. markets will also close early on Tuesday. The domestic economic calendar is light, featuring consumer confidence, new home sales, and trade balance figures. Overseas, the focus will be on Japan’s inflation updates and minutes from their recent central bank meeting. For the week of December 30 there are only a few economic releases of note, including U.S. housing data, U.S. ISM manufacturing PMI, and China’s government PMI survey results. The December jobs report, which would typically arrive the first Friday of the following month, will not be released until January 10 due to the holiday schedule.
CHART OF THE WEEK
Dot plot update
Wednesday’s FOMC decision triggered a sharp selloff in U.S. equities and a volatility spike to levels not seen since August. The reaction was largely caused by the updated “dot plot”—the chart that records each Fed official’s projection for the bank’s key short-term interest rate—in the Summary of Economic Projections (SEP). The chart below shows the median projection for the fed funds rate at the end of each of the next three years with September’s estimates in blue and the current in red. As you can see, forecasts have moved higher, with year-end 2025 now at 3.9% versus 3.4%. This implies only two rate cuts next year instead of four. For 2026 the estimate is 3.4% versus 2.9% previously, while 2027 stands at 3.1% versus 2.9% prior. However, there is a wide range for each year, and there is little agreement on what the “terminal rate”—the longer-term target rate for this cycle—should be. In the SEP, the Fed also revised its forecasts for economic growth and inflation higher in the next two years, which would support being more cautious on future rate cuts. Projected headline PCE for 2025 was adjusted to 2.5% from 2.1% to account for potential inflationary factors such as a continued strong economy, tight labor markets, larger government deficits, and rising tariffs. The 2-year Treasury note, which is viewed as a proxy for where investors think the fed funds rate (currently 4.25- 4.50%) might be one year from now, sits at 4.3%, up from 3.5% just three months ago. While inflation has moved significantly lower over the past year, it seems investors are bracing for uncertainty moving into 2025 and adjusting their interest rate expectations accordingly.
Source: Charles Schwab Corporation
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