Wall Street Cheers as Fed Takes Pause, But Eyes Bumpy Economic Landing Next Year

U.S. equities are poised to reach new highs as a result of the Federal Reserve's dovish stance, but some investors are concerned that the market may be moving too quickly given the uncertain outlook for the economy and corporate earnings.

In addition to keeping interest rates unchanged on Wednesday, the Fed also hinted in fresh economic estimates that the record tightening of U.S. monetary policy that has been in place over the past two years is coming to an end and that lower borrowing costs will be returning in 2024.

Dovish Fed Signals Spark Market Rally

Contrary to what many investors had anticipated, the message was more dovish. The S&P 500 saw its largest increase since July 2022 on Wednesday, when the Fed released its monetary policy statement, thanks to falling Treasury rates, which helped the index jump by around 1.4%.

In late Wednesday trade, the benchmark U.S. 10-year Treasury yield, which is inversely correlated with bond prices, dropped to about 3.99%, its lowest point in four months. Though markets are still significantly more dovish in their forecast, the Fed's perspective is now more in line with that of investors.

The policy rate is expected to decline from its current range of 5.25% to 5.50 percent by the end of 2024, according to the projections of 17 out of 19 Federal Reserve members.

Based on LSEG statistics, it contrasts with the Fed's policy rate, which is represented in futures at a rate of 3.847%.

The S&P 500 may have the momentum to finish the year by matching or surpassing the closing high it achieved in January 2022 since there aren't many significant macroeconomic developments anticipated for the remainder of December. The index is now less than 2% behind the 4,796.56 record. The world's most valuable corporation, Apple Inc., and the Dow Jones Industrial Average both closed at new highs on Wednesday-the first since January 2022.

Assessing Seasonal Boosts and Investor Sentiment

Seasonal considerations might offer a boost: December has historically been the third-best month for the S&P 500 since 1950, with LPL Financial statistics showing that the second half of the month is usually better than the first.

Support may also come from investors who were previously bearish selling their stakes. Leveraged funds "are not bullish and continue to fight rallies" in equities, according to data from BofA Global Research, which the bank released in a recent study. This is after they increased their net short position in response to the S&P 500's fourth-quarter surge.

Even still, a lot of investors are curious about how much of the Fed's dovishness has already been taken into account during this year's surge, which has seen the S&P 500 increase more than 22%. The economy has to tread carefully in order to fulfill the "Goldilocks" story of declining inflation and robust growth in the upcoming year.

LSEG Datastream reports that the S&P 500 was recently trading at 19.1 times forward earnings forecasts, compared to its long-term average of 15.6 times. LSEG data projects that S&P 500 business earnings will climb by 11.4% in 2024, following a 2.6% increase in 2023.

The market is "far, far more aggressive in cuts than even what the Fed let on in a very dovish statement," according to Mike Sanders, head of fixed income at Madison Investments.

Sanders, who is optimistic on five-year Treasuries, stated that the major emphasis of the upcoming six months would be on whether inflation can continue to decline while the jobs situation stays solid. "We must ensure that the soft landing serves as more than just a setup for a hard landing," he stated.