After Solid Data, Wall Street Dials Back Fed Wagers

Stocks experienced declines alongside other risk assets as bond yields rose, fueled by speculation that the Federal Reserve would refrain from hastily reducing interest rates due to signs of resilience in the economy.

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In an era where positive economic developments are not perceived as extraordinary from a policy standpoint, robust figures in retail sales and housing raised concerns about Wall Street's assertive dovish stance. As central bank officials adopted a more cautious outlook on easing prospects, it created an ideal scenario for traders to postpone the anticipated timing of the first Fed moves, diminishing the likelihood of a reduction in the first quarter.

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Tom Essaye, founder of The Sevens Report newsletter and a former Merrill Lynch trader, emphasized the necessity of data consistent with a healthy and resilient consumer. However, this should not be to the extent that the Fed would be inclined to delay rate cuts or reduce them less in 2024.

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Fed swaps currently indicate a probability of easing as early as March dropping below 60%, a decrease from the 80% reported on Friday. The S&P 500 extended its 2024 losses, and Treasury two-year yields exceeded 4.3%. Meanwhile, the dollar surged to a one-month high, and Wall Street's volatility index, the VIX, reached its highest level since November. The MSCI Emerging Markets Index of stocks experienced a 2% decline, with the overall risk-off sentiment also impacting oil prices.

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According to Andrew Hunter at Capital Economics, while there may be a further economic slowdown ahead, there is little evidence to suggest a more severe downturn is imminent.

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Quincy Krosby at LPL Financial pointed out that December retail sales indicate an economy that, while slowing, continues to be supported by consumer spending. Krosby noted that slower consumer demand could contribute to a faster deceleration of inflation for the Federal Reserve. However, with consumer confidence gaining momentum, the economic landscape remains robust, making the market's hope for a March rate cut increasingly elusive.

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Jason Draho at UBS Global Wealth Management anticipates a bumpy road ahead for markets. He suggests that investors will be engaged in debates about the type of soft landing, the stage of the economic cycle, and the macroeconomic regime. The wide range of views currently held by market participants could swiftly evolve based on new data, potentially leading to rapid and dramatic market shifts as consensus views change.