The Fed delivers its message with a dovish tilt

Key Takeaways:

  • Last week, the Federal Reserve held its March FOMC meeting and press conference and also released an updated set of economic projections. The Fed left the fed funds rate on hold at 5.25% - 5.5%, but its updated "dot plot" still pointed to three rate cuts in 2024. The FOMC also sees the fed funds rate gradually heading to around 3.1% by 2026, indicating that this year is likely the start of a multiyear rate-cutting cycle.
  • Heading into the meeting, markets remained uncertain whether the Fed would maintain its outlook for rate cuts this year, especially as inflation readings for January and February were somewhat hotter than expected. However, Fed Chair Jerome Powell noted in the press conference that the Fed sees "inflation coming gradually down to 2% on a sometimes-bumpy path."
  • Overall, markets welcomed the more dovish messaging coming out of the Fed and Chair Jerome Powell, who did not take the opportunity to push back on rising stock prices and easing financial conditions. We saw stock markets reach new highs and bond markets move higher, as Treasury yields softened last week. The more cyclical parts of the market, including small-cap and mid-cap stocks and sectors like industrials and financials, were among the top-performing for the week. The better economic outlook and potential for lower interest rates may be longer-term catalysts for a broadening of market leadership.
  • In addition to the Federal Reserve, major global central banks, including the Bank of Japan (BoJ), the Swiss National Bank (SNB), and the Bank of England (BoE), also held policy meetings last week. The BoJ raised interest rates for the first time in 17 years, from -0.1% to 0.1%, abandoning the negative interest-rate policy regime after eight years.

Three key takeaways from the Federal Reserve March meeting

  1. The rate-cutting cycle remains on track to begin this year: Perhaps one of the most welcome dovish tilts in the Fed's updated set of projections was that its "dot plot" continued to show a meaningful downward trajectory in rates over the next three years. The Fed dots maintained the outlook for three rate cuts in 2024, although the margin among the 19 voting members was tight. There were 10 members in favor of three rate cuts (or more) in 2024, while nine members voted for fewer rate cuts this year.

    Regardless of when the cutting begins, more importantly the Fed continues to see the start of a multiyear rate-cutting cycle sometime this year. The FOMC outlined a path for the fed funds rate that would take the policy rate from 5.25% - 5.5% down to 3.1% in 2026. This was slightly higher than its December update, which showed the fed funds rate falling to 2.9% in 2026. Nonetheless, the Fed reaffirmed its view that current policy rates will likely come down to a more neutral level, barring any external shocks, and that the need for restrictive policy has diminished.
 Chart showing the Fed "dot plot" points to a multi year rate cutting cycle
Source: FOMC, as of March 20, 2024.
  • Keep in mind that the Fed does not see policy rates returning to the zero range, where they were in the period following the 2008 financial crisis. In the next three to five years, the fed funds rate may be closer to the 2.5% - 3.0% range outlined in the Fed's updated projections last week. In our view, this implies that long-term Treasury yields may also remain elevated versus the post-crisis period, and investors may continue to see bonds playing a more meaningful role in portfolios, particularly those seeking fixed income. 
  1. The Fed upgraded its outlook for economic growth – the "soft landing" narrative remains intact: The Fed also took the opportunity to upgrade its economic growth outlook for 2024 - 2026. The December estimates had indicated that real GDP growth in the U.S. may soften to 1.4% in 2024, down from 2.5% in 2023, before gradually returning to 1.9% by 2026. The Fed's new forecast points to GDP growth of 2.1% in 2024, followed by 2.0% growth rates in 2025 and 2026. As Powell noted during the press conference, "The economy is strong, the labor market is strong, and inflation has come way down." The Fed also sees the unemployment rate ticking modestly higher to 4.0% in 2024, up slightly from 3.9% currently. 
 Chart showing the Fed upgraded its Outlook for real GDP growth in 2024-2026
Source: FOMC, as of March 20, 2024.
  • Perhaps another key focus area for investors heading into last week's FOMC meeting was the Fed's view on inflation. After the January and February consumer price index (CPI) inflation readings came in somewhat hotter than expected, there was some concern that the trend in inflation may be moving in the wrong direction, especially given the ongoing resilience in consumer spending. However, while Jerome Powell did underscore that the Fed will be data-dependent and that inflation remains above the Fed's target still, he also noted (twice) during the press conference that the Fed views "inflation coming gradually down to 2% on a sometimes-bumpy path." So overall, the Fed's view reaffirmed the narrative that inflation could gradually reach 2.0%, even as the U.S. economy maintains a healthy 2.0% growth rate. In our view, while the last mile to 2.0% inflation may not be a straight line, we do see a path for inflation continuing to moderate, especially if the shelter and rent components of the CPI basket start to catch up with real-time data and ease further from here.
  1. The pace of balance-sheet tapering may slow -- another dovish tilt by the Fed
    Finally, Fed Chair Jerome Powell noted in the press conference that it will be appropriate for the Fed to slow the pace of its balance-sheet-reduction program, often referred to as quantitative tightening (QT), fairly soon. The Fed has reduced the size of its overall holdings from a peak of around $9 trillion in April 2022 to now close to $7.5 trillion. It has done this by allowing around $95 billion per month in Treasuries and mortgage bonds to expire and not be replaced. This quantitative-tightening program has generally been viewed as another form of restrictive policy by the Fed, alongside its interest-rate-hiking campaign, as the Fed has no longer been a buyer of bonds in the market and instead is withdrawing liquidity from the financial market. 
  • While Powell did not specify the timing of when the pace of QT will slow, in our view this is likely also to be a 2024 announcement. And although the pace of balance-sheet taper may not have the same impact as outright cuts in interest rates, we believe the shift in both of these policies point to the Fed moving in the direction of policy easing, which should be welcomed by investors and financial markets broadly.
 Chart showing the level of the Fed's balance sheet.
Source: Bloomberg.

The Fed was not the only major central bank with policy meetings last week

In addition to the Federal Reserve, several major central banks globally also delivered policy-rate decisions last week. Overall, a large majority of developed-market central banks are on a similar path as the Fed, likely heading toward rate cuts sometime this year, including the European Central Bank (ECB), Bank of Canada (BoC), and Bank of England (BOE). Last week alone the Swiss National Bank surprised markets by cutting rates by 0.25% to 1.5%, noting that "the fight against inflation over the past 2.5 years has been effective." The BOE also met last week and kept its policy rate on hold at 5.25%, although investors anticipate that the central bank will begin cutting rates gradually starting in the August timeframe.

Perhaps one notable exception has been the Bank of Japan (BoJ), which raised rates last week for the first time in 17 years. The central bank took rates from -0.1% to a range of 0.0% - 0.1%, abandoning its negative interest-rate policy after eight years. The Japanese economy has been an exception among developed nations, as it has been long struggling with stagnant economic growth and low inflation. This has shifted over the past year, as inflation has risen in Japan in the post-pandemic period, wage growth has increased, and economic growth and profitability have returned to a large extent. As a result, Japan's Nikkei stock index has returned close to 50% over the past 12 months, and government bond yields have shifted higher.1 While the move higher in Japanese yields hasn't had a substantial impact on global markets, Japanese yields are also one driver for the direction of U.S. and global rates over the long term. 

 chart showing the Japanese 2- and 10-year government bond yields and the Bank of Japan (BoJ) policy rate.
Source: Bloomberg.

Market leadership broadened with the prospect of rate cuts and better economic growth – this theme may continue

Overall, markets welcomed the more dovish tone that came out of the Federal Reserve last week. The S&P 500 rose over 2% last week, and all major stock indexes trended higher. Notably, the small-cap and mid-cap indexes outperformed the broader S&P 500 after the Fed meeting on Wednesday.1 And underneath the surface, the S&P 500 gains were also driven by a broader set of sectors beyond technology. These included cyclical sectors like financials, energy, and industrials. We also saw investment-grade bonds perform well last week, as Treasury yields moved lower after the Fed meeting and reaffirmation of potential rate cuts.1 

 This chart showing the S&P 500 sector returns
Source: FactSet, year-to-date S&P 500 GICS sector returns.

In our view, this theme of broadening market participation beyond mega-cap technology is a welcome sign of a healthy market dynamic. As the potential catalysts of Fed rate cuts, some easing in inflation, and better and broader earnings growth this year unfold, we see the theme of broadening market leadership continuing to play out. While the market rally may not continue in a straight-line indefinitely, we would recommend investors use periods of volatility as opportunities to diversify and prepare for a further broadening of participation. We favor large-cap and mid-cap stocks, as well as cyclical and value sectors including industrials, consumer discretionary, and utilities. In fixed income, we continue to see an opportunity to extend duration with investment-grade bonds, especially ahead of a potential Fed pivot to rate cuts and a lower-yield environment in the years ahead.

Mona Mahajan
Investment Strategist

Sources: 1. FactSet 

Weekly market stats

Weekly market stats
INDEXCLOSEWEEKYTD
Dow Jones Industrial Average39,4762.0%4.7%
S&P 500 Index2,351.571.1%5.2%
NASDAQ16,4292.9%9.4%
MSCI EAFE*2,3561.3%5.4%
10-yr Treasury Yield4.20%-0.1%0.3%
Oil ($/bbl)$80.82-0.3%12.8%
Bonds$97.810.7%-1.2%

Source: FactSet, 3/22/2024. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results. *Morningstar Direct 3/24/2024.

The week ahead

Important economic releases this week include consumer confidence and PCE inflation data.

Review last week's weekly market update.


Mona Mahajan

Mona Mahajan is responsible for developing and communicating the firm's macroeconomic and financial market views. Her background includes equity and fixed income analysis, global investment strategy and portfolio management.

She regularly appears on CNBC and Bloomberg TV, and in The Wall Street Journal and Barron’s.

Mona has a master’s in business administration from Harvard Business School and bachelor's degrees in finance and computer science from the Wharton School and the School of Engineering at the University of Pennsylvania.

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