Weekly Market Update: December 28, 2023
Treasury market yields continue to fall. The yield on the 10-year Treasury note, which is used as a proxy for various longer-term rates, recently dropped to 3.90%. That level was more than a full percentage point below its 2023 peak in late October. The falling Treasury yields have sparked a broad-based equity market rally.
A series of “goldilocks” economic reports have played a huge role in the significant decline in Treasury yields. Specifically, the Labor Department reported that the nation added an estimated 199,000 jobs in November, a pace that is indicative of a still-tight labor market. The job gains were accompanied by a decline in unemployment and an increase in the labor force participation rate. The latter was an encouraging sign, as more workers seeking employment should serve as some restraint on wages. Wage trends are a key factor for the Federal Reserve in its effort to reduce inflation.
The Fed also telegraphed at this month’s Federal Open Market Committee (FOMC) meeting that it may be done raising the benchmark short-term interest rate. The central bank held the federal funds rate steady at 5.25% to 5.50% for the third-consecutive FOMC meeting and then hinted that it may begin cutting rates in 2024. Our sense is that we could see as many as three cuts in the second half of 2024, bringing the federal funds rate down by roughly three-quarters of a percentage point. This scenario is likely predicated on inflation continuing to ease and a “soft landing” for the U.S. economy. The Fed has lowered its 2023 Personal Consumption Expenditures (PCE) Price Index estimate from 3.7% to 3.2%.
The next big event for Wall Street is fourth-quarter earnings season, which commences in a few weeks. The results and, maybe more so, company prognostications will provide more insight on the state of the U.S. economy. Solid profit growth also will be needed to justify the elevated price-to-earnings multiple for the S&P 500 Index, which recently traded near 20 times average profits.
Conclusion: The decline in Treasury market yields has fueled a notable year-end “Santa Claus” rally in the equity market. For this buying to continue in 2024, we think further progress on the earnings front will be needed.